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Why the Payroll-Tax Cut May Not Be as Bad as Consumers Fear Why the Payroll-Tax Cut May Not Be as Bad as Consumers Fear

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Economy

Why the Payroll-Tax Cut May Not Be as Bad as Consumers Fear

The payroll-tax cut may not hit consumer buying power by as much as first thought. (UPI/Alexis C. Glenn)(UPI/Alexis C. Glenn)

photo of Catherine Hollander
February 1, 2013

Paychecks may be smaller this year, but an alternative measure of inflation may put consumers concerned about their thinner-than-usual wallets at ease.

The cost of day-to-day living decreased as 2012 came to an end, according to a new study from American Institute for Economic Research, lessening the perceived blow of the year-end expiration of a 2 percentage point payroll-tax cut. With the end of the cut, people making $50,000 will pay an extra $1,000 in taxes this year.

AIER’s Everyday Price Index, intended to better reflect consumers' daily experiences than the government’s official Consumer Price Index, found that the cost of frequently purchased goods and services declined in each of the final months of 2012, including a 0.8 percent drop in December. Over the year, AIER found that price inflation averaged 2.5 percent.

 

“Consumers are kind of fortunate,” said Steven Cunningham, AIER’s director of research and education and the architect of the alternative price measure. “[The higher taxes] might otherwise depress demand with falling disposable income, but if, you know, if everyday prices are less, which is what we're saying, then it looks as though the everyday prices are going to be down by roughly as much as the increase in payroll taxes so that people’s buying power will remain more intact,” he said. 

The government-issued CPI for December, by contrast, was unchanged.

The payroll-tax cut took a toll on consumer confidence. Separate measures of confidence released this week by the Conference Board and Thomson Reuters/University of Michigan each showed the impact of smaller paychecks. “The end of the payroll-tax holiday had a significant impact on consumer confidence, especially among lower-income households,” Richard Curtin, director of the Thomson Reuters/University of Michigan Surveys of Consumers, said in a statement Friday.

The Everyday Price Index relies on the same survey data as the CPI, but excludes items purchased less frequently, like cars and computers, as well as fixed expenses, like rent. Unlike the CPI, it’s not seasonally adjusted. It’s more volatile. (Read more about the EPI methodology).

It’s not a replacement for the CPI (although statisticians and social scientists have explored ways to better measure consumer prices). Nor is it meant to be a criticism of CPI, Cunningham is quick to say. They’re just different, he said. The CPI is focused on the purchasing power of the dollar. The EPI is more focused on consumers' daily experiences. 

Neither index shows signs of runaway inflation, a common fear voiced by critics of the aggressive and easy monetary policies the Federal Reserve has pursued during the financial crisis and its aftermath.

Higher payroll taxes were the outcome of the first budget battle of 2013: the fiscal cliff, a combination of year-end tax hikes and spending cuts. The New Year's Day agreement to blunt the impact of most of the cliff's components did nothing to stop the expiration of the payroll-tax cut. More fiscal fights loom; next up is a debate over preventing automatic, across-the-board spending cuts that are set to kick in on March 1. Many economists warn that the cuts, if enacted, would slow growth in 2013.

How consumers handle the outcome of these negotiations will, in part, be determined by how the cost of day-to-day living changes, and this alternative measure holds out a bit of hope for consumers—at least for the moment. You don't want inflation to decline for too long

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