On New Year’s Day, President Obama proclaimed his “bipartisan solution” to the fiscal cliff was “a victory for middle-class families and the economy.” That V sign must have seemed premature to the more than 120 million Americans who logged in to their bank accounts later that month and found that their pay had been suddenly slashed. The paycheck shock may be the biggest threat to our anemic economic recovery.
Why did Americans find that they had gotten the opposite of a two percent raise – or about $45 less every two weeks on average, according to Congress’ Joint Economic Committee?
Two years ago, Obama did a tax deal with the Republican Congress to extend the Bush tax cuts. That 2011 law included a boost to everyone’s paycheck. Instead of paying 6.2 percent of their pay to Social Security, Americans would pay 4.2 percent, keeping $1,035 more a year.
The payroll-tax cut wasn’t a great idea in the first place. There was never any evidence that Americans really even noticed the modest boost to their income.
Yes, Americans had sharply cut back spending in 2008 and early 2009. But they slowly started spending again in 2010, before the payroll-tax cut. They didn’t really start spending on things like restaurant meals and apparel – largely unnecessary items – until shortly after last year’s election, well after the tax cut took effect.
The reason for the eventual pickup? Enough people finally had shed enough of their debt, whether through defaulting on their mortgages or slowly slogging through monthly credit-card balances, to feel comfortable splurging on something again. The fact that more people are working helps, too.
But if the payroll tax wasn’t necessary, it’s a far worse idea to take it away. It’s not just the pure economics of it. Economics, of course, would already tell you that if the payroll tax did help the economy, even a little, it’s going to hurt the economy to take it away.
That’s what happened in Britain, when the supposedly conservative David Cameron government hiked the value-added tax on goods and services by 14.3 percent, to 20 percent from 17.5 percent. People markedly cut back their spending because they had less money to spend.
But the psychology of the payroll-tax move matters more than the economics. Enacting the tax cut and taking it away doesn’t have the same result as never doing anything at all.
Think of it this way: If you give your friend a gift, she’ll be pleased; if you say in a month that you’ve decided you want it back, she’ll be less pleased than if you never gave it to her in the first place.
This thinking is just as important to the economy. Americans have been through nearly seven years of hell, starting in the spring of 2006. (They figured out that the housing bubble burst a year before Wall Street did, and two years before Congress did).
They’ve lost their job or worried about it. They’ve seen Wall Street get bailed out. They’ve watched supposed political leaders cry wolf about a government-funding crisis now for years. They’ve delayed buying homes, going to school, having kids.
And now that things have sort of, kind of, maybe started to look up, what does the government do? It slaps them with a massive tax hike. To rub salt in the wound, Democrats and Republicans both seem completely oblivious to the fact that that’s what they’ve done. They’re going around congratulating each other for cutting taxes.
Don’t be surprised if Americans have decided they’ve had about enough of this – and go on a spending strike. They know full well that the government likes them to spend money, but maybe they won’t feel like doing their patriotic duty for a while.
Nicole Gelinas is a contributing editor to the Manhattan Institute’s City Journal. @nicolegelinas on Twitter.