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Why The Newly Reinstated Payroll Taxes Won't Drag Down The Economy

Jan 11, 2013, 22:16 IST

Sources: "A Boost In Your Paycheck: How Are US Workers Using The Payroll Tax Cut?", Federal Reserve Bank of New York Liberty Street Economics, UBSAmericans only spent about two-fifths of the extra cash they got from the 2009 payroll tax cuts.If you've already received your first paycheck of the year, then you've probably noticed that it was a teeny bit smaller than expected.

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That's because when the temporary cut in payroll taxes expired at the end of last year, policymakers decided to let them stay that way as a part of the fiscal cliff tax deal, also known as "American Taxpayer Relief Act of 2012."

Now that these payroll taxes are back, the US government can expect to collect revenue equivalent to about 0.66% of GDP, according to a report by UBS' global macro team. That's a reduction of around $115 billion in the disposable incomes of American households.

So Americans are going to end up spending a little less than they would have, right?

Not really says UBS. Turns out, the payroll tax cut didn't really do much to increase spending in the first place.

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"The negative consumption impact from the Social Security payroll tax rise should be far less than the estimated $115 billion hike in such taxes this year. That is because the temporary two percentage point Social Security tax rate cut in 2011-2012 was not a big consumption booster."

This keeps in line what's happened in the past—like in the 1960's, when the US government enacted a temporary income tax surcharge, spending only reduced by 35 cents on the dollar of the extra revenue.

The tax deal also enacts heavier taxes on higher income households, most significantly effecting those making $500,000 a year or more. But this will probably result in a drop in savings, not so much a reduction in spending, said the report.

"Higher Federal income taxes on relatively wealthy taxpayers should be accompanied by a drop in savings that limits the negative near-term consumer spending impact. Saving rates increase sharply at higher income levels, with the saving rate estimated at 51 cents on the dollar for the top 1% of the income distribution and 37 cents on the dollar for the top 5%."

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