Americans Pinched by Payroll Tax, so What Gets Cut?

Lawmakers’ decision not to extend the payroll tax at the start of the year has not only dampened consumers’ spending habits, but also their social lives.

The payroll tax rate increased to 6.2% from 4.2% at the start of the year under a plan on Capitol Hill to help advert the fiscal cliff. The temporary payroll tax was put in place in 2010 to help boost Americans’ paychecks and spur consumer spending during the tough economic environment.

As a result of the reduce paychecks, which is an average $130 less a month, Americans are cutting back on their socializing and workday spending, according to a new survey.

According to the survey from Accounting Principles, 20% of respondents have cut back on going to bars and restaurants because of the tax hike, and 19% have given up eating lunch out. These activities are a big part of consumer spending: the survey found 82% of Americans buy coffee regularly, spending about $20 a week, while 89% average more than $35 weekly on lunch. API surveyed 1,000 working Americans for the study.

Turning to Retirement Savings

To help cope with a reduced paycheck, survey respondents report tapping into their 401(k) savings.

The survey found 25% are using their retirement savings for health-care costs, 27% are using it for home or car repair, and 22% are using the savings to help make ends meet during unemployment. Men (29%) were nearly twice as likely as women (15%) to cite unemployment as a reason to use these savings.

“People will tighten their spending, and it will certainly have an impact on buying patterns,” Chavez says. “They will look for more resources or a cheaper way to get things—like a less expensive cup of coffee in the morning. They are so used to getting those things; they will continue to look for them, just cheaper.”

Others are using their 401(k) savings for discretionary spending , a trend that that surprised Jodi Chavez, senior vice president of Accounting Principles.“They are pulling from their 401(k) for leisure type activities. In the short-term this may help the economy in certain industries, like construction, if they are using it for home remodeling.”

But if Americans fail to replace the money they borrow from their accounts, they will have less funds to tap in retirement, which creates more economic problems since the economy relies heavily on spending from retirees.

Doing the Math

This tax increase is on the first $113,700 in earnings, according to Michael Sonnenblick, tax analyst at Thomson Reuters, and impacts earners differently.

He offers these two examples:

A single individual making $113,700 annually will see his or her taxes increase to $17,000 from $14,700 a year with the standard deduction.

A single individual making $400,000 a year will see his or her taxes increase to $84,000 from $81,700. Both groups see their taxes increase by $2,274, however the percentage of their income lost is quite different, Sonnenblick stresses.

Lower-income earners will feel the tax hike more than high-earners, losing more of their budget to Uncle Sam.

“For the person making $113,700 a year, before the 2% tax hike, the blended tax bracket was 12.92% of their income, and that increases to 14.93%-- its two percentage points but is 15.5% of an increase,” he says. “For the person making $400,000 a year, its much less, because this tax is capped at $113,6700. From a tax perspective it’s regressive. They have a bigger economic effect on lower earners.”

Making Up for the Loss

Consumers feeling the squeeze from the increase need to review their budget, spending habits and debt situation immediately, recommends Rob Lutts, CIO of Cabot Money Management.

For debt-laden people, he suggesting finding credit cards that offer low interest rates, especially if you carry a balance. “There are many offerings out there and some people don’t even know what they are paying.

Next, take a look at non-essential spending and cut back. One place people often overlook is spending on utilities. Lutts advises being more efficient when using electricity, heat and air conditioning  “It may be worth it to throw on a sweater. A lot of people don’t turn their thermostat when they leave for work for the day.”

To create a new budget under the new available income, write down exactly what you buying and how much for two weeks. Then review the list and identify and “impulse buys” you can doo without. Lutts says there are many free apps that can help monitor and track spending to help stay on budget.

“Keep track of the money you are spending more and what you can do without. I bet you can shave back about 5% of that impromptu spending. This makes you more aware.”