As payroll taxes rise, the middle and lower classes will spend less at stores—and the corner bar.
Already moody from the uneven economic recovery, consumers are about to get a lot grumpier. The first pay period of the year ushered in higher Social Security taxes, which are expected to suck more than $1 billion from spending in 2013, presenting marketers with yet another challenge as they seek to pry precious dollars from shoppers.
Paychecks began shrinking Jan. 1, when the tax rate jumped to 6.2% from 4.2%, ending a temporary break that began in 2011. For a household making $50,000 a year, that means a loss of about $83 a month, or $1,000 a year. The payroll tax applies only to wages up to $113,700. Various analysts have projected anywhere from a $113 billion to $120 billion hit to the economy, with most agreeing the keenest pain will be felt in the first quarter as consumers adjust. IHS Global Insight cited the higher taxes when lowering its first-quarter consumer-spending growth projection to 1.4% from 2.6%.
For the middle and lower classes, “any hit to their income will affect their spending patterns,” said Greg Daco, an IHS Global economist, adding that consumers could shell out less for groceries, clothing, toys and more. “They are going to, wherever possible, limit their spending to essentials if their budgets are tight.”
For industries that rely on spending from blue-collar workers, the hit could not come at a worse time. Look no further than the corner bar, where beer sales had begun to stabilize after a multiyear slump thanks to the decreasing unemployment rate. But in the fourth quarter, as fears rose of higher taxes and the fiscal cliff, sales slumped again. The number of beers sold at bars and restaurants in the quarter fell 2%, compared to a modest 0.5% drop in the first nine months of the year, according to GuestMetrics, which tracks the hospitality industry.
“The initial sticker shock of having your paycheck go down will affect beer demand,” especially in the first quarter, said Harry Schuhmacher, editor of Beer Business Daily. As a result, marketers will face more pressure to keep sales steady with effective ads and in-store marketing, he said. “There’s going to be a real big focus on retail execution—getting big displays out there,” he said. “Beer is not going to be on the grocery list. So to overcome that, they’ve got to generate impulse buys.”
In a report last week, Bernstein Research stated that the tax hike will hurt middle-and-upper income consumers the most because low-income households typically derive a share of income from nonwage sources such as government assistance. As such, Bernstein projected that discount retailers, such as dollar stores and Walmart, will be insulated and might even stand to benefit as consumers trade down. But department, general-merchandise, apparel and home-furnishing stores face higher risks, Bernstein stated, citing marketers such as Target, Best Buy and Williams-Sonoma.
Morgan Stanley took a slightly different view, saying that marketers catering to lower-income households will suffer the most. In a report last month, it projected that the tax hike would decrease “discretionary-spending capability” by 6% for people who make less than $40,000, noting that “most households at this level spend all that is available to them.” As a result, Morgan Stanley projected headwinds for retailers that cater to the teen market, such as Aeropostale, as well as restaurants that target the low end, including KFC, Pizza Hut, Taco Bell, Domino’s and McDonald’s. This might explain the rash of value-oriented marketing in the sector of late. “Many consumers will be faced with making hard choices about where to eat and how much they have to spend at restaurants,” said Darren Tristano, exec VP at Technomic, a restaurant consultant.
Conversely, packaged-food brands could benefit as people eat at home more often. That was the case when the recession took hold in 2008, noted Todd Hale, Nielsen’s senior VP of Consumer & Shopper Insights. “I would expect that we are going to see some return to that, but not completely, because things are not as dire as they were back then.” But in the short term, at least, shopping patterns are likely to change. Sales of private-label products—which have been relatively flat—could rise some, Mr. Hale said. Also, consumers, at least for a little while, might use more coupons after cutting back on them last year as the economy rebounded, he said.
The question is how much of the tax-rate hit will be blunted by positive factors, such as the improving unemployment rate, rising housing market and fairly stable gas prices. David French, senior VP-government relations of the National Retail Federation, noted that when the tax cut was put in place two years ago, the organization’s members did not report much of a boost largely because of higher energy costs, which ate up the new consumer cash. “Today, ironically, we kind of have a mirror-image situation: As the tax cut has lapsed, energy prices have fallen,” he said. The tax hike, he said, is “probably going to be somewhat lost in the wash of other economic factors.”
Either that, or consumers are about to take marketers to the cleaners.