Will Higher Payroll Tax Rates Really Crimp Consumer Spending?

by James Brumley | February 27, 2013 10:26 am

When Sears Holdings (NASDAQ:SHLD[1]), JCPenney (NYSE:JCP[2]) and Kohl’s (NYSE:KSS[3]) and report last quarter’s earnings this week, take the numbers with a grain of salt. While retailers might have been feeling the effects of a tailwind at the end of 2012, they’ve all hit a headwind since Jan. 1 that isn’t showing up in the numbers yet.

That headwind is the end of the temporary payroll tax break that reduced American workers’ tax burden by a total of 2% of their income. The sunset clause built into that stimulus effort ended at the end of last year, so as of the beginning of 2013, U.S. workers are taking home 2% less than they were just a couple of months ago.

Although 2% doesn’t seem like much, collectively, it means employees will have $110 billion less to spend in 2013 than they did in 2012. The question is: Will consumers actually crimp down on retail spending?

Thinking Ahead

Anyone making $50,000 per year will be taking home about $1,000 less this year, thanks to Social Security taxes ramping back up to a rate of 6.2% of income. More than a few companies are bracing for the worst.

Walmart (NYSE:WMT[4]), for instance, lowered its 2013 revenue and profit forecast to reflect consumer tax burden. Kraft Foods (NASDAQ:KRFT[5]), Darden Restaurants (NYSE:DRI[6]) and Burger King (NYSE:BKW[7]) all reeled in outlooks for 2013 as well. Even Dollar Tree (NASDAQ:DLTR[8]) — perhaps the pinnacle proxy for value-based shopping — expects lower levels of take-home pay to hurt the top and bottom line.

The solution to the consumerism clamp-down depends on the company in question. Walmart is adding more lower-priced goods to its mix. Burger King is lowering prices for several of its products. Tyson Foods (NYSE:TSN[9]) will unveil more economical options to its customers.

And why not? After all, 45% of consumers plainly said they’d be spending less this year because they were bringing home less money. If these companies want to remain in business, they’ll need to meet the new needs of consumers.

But …

There’s just one flaw in the whole assumption that 2013 is going to be a rough year for retailing … there’s not one shred of evidence that consumers are spending less money now than they were last year.

January’s retail sales were 0.1% higher than December’s spending. It’s not a significant improvement, but consider that December is always a strong month for Christmas sales, and there are no gift-giving holidays in January. And, January 2013’s retail sales were a whopping 4.7% better than January 2012’s total.

In other words, shoppers are saying one thing and doing another.

It wouldn’t be the first time this has happened. Two years ago, when payroll tax rates were temporarily cut in an effort to spur consumer spending, Walmart didn’t see any measurable benefit from the measure. The undoing of that measure might well have the same non-effect.

Indeed, when Macy’s (NYSE:M[10]) announced it topped EPS estimates of $1.99 by bringing home $2.05 per share last quarter, it also cranked up its earnings outlook for the coming year. Prior estimates had pegged 2013’s bottom line at $3.84 per share, but the company now says $3.95 is a more accurate guess. That doesn’t exactly suggest consumers are suddenly cash-strapped, or perhaps more accurately, not every demographic or target market is cash-strapped.

Bottom Line

A few more retailers will be reporting last quarter’s results this week; some of them will even be posting today. Those earnings and outlooks are important, but even more important will be the clues they might drop about this year’s outlooks, and the impact that slightly higher payroll taxes might have. Those hints won’t be in the results themselves, so pay attention to the comments and any outlooks that go along with those results.

One possibility to consider: Based on what we’ve seen so far, lower-income consumers catered to by the likes of Walmart and Dollar Tree might be feeling the pinch, while mid- to upper-income consumers being targeted by Macy’s and Saks aren’t going to be impacted as severely, if at all. Indeed, that seems to be the shape of things at this point.

The same goes for Home Depot (NYSE:HD[11]); it’s thriving as middle- and upper-income families brush off slightly higher tax rates and continue to buy new homes and repair or upgrade existing homes. Darden might also be better shielded from the tax hike than it’s giving itself credit for; $80 per month isn’t exactly life-changing either way for the middle class.

Ironically, Dollar Tree might be one of the names at the extreme losing end of this deal, as this new tax rate impacts its target demographic relatively more than other demographics. Though Big Lots (NYSE:BIG[12]) hasn’t groused the way Dollar Tree has, it’s in the same proverbial boat as Dollar Tree. Count Burger King in that group.

Whatever the case, perhaps JPMorgan economist Michael Feroli offers the wisest point of view regarding the impact of the new payroll tax rates, commenting that “Evidence from past episodes suggests it could take up to two quarters for spending to fully adjust to new tax realities.” That history means we all might want to wait until past the middle of the year before jumping to conclusions.

The fact is nobody really knows how this is all going to shake out.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2013/02/will-higher-payroll-tax-rates-really-crimp-consumer-spending/

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