• POLITICS
  • Updated February 7, 2013, 8:43 p.m. ET

Tax Holiday Ends, Consumers Scrimp

Higher Payroll Taxes Are Putting a Chill on Spending, According to Some Businesses, Though Retail Sales Are Mixed

By NEIL SHAH

Most Americans who draw a paycheck saw their tax bill go up last month when a payroll-tax holiday expired. The question is whether that is prompting consumers to curb spending, just as the economy is struggling to gain traction.

Some early signs suggest they are tapping the brakes. Surveys show the majority of Americans who are aware of the tax increase say they plan to cut spending, and consumer confidence has wavered. Companies like Target Corp. and women's clothier Cato Corp. say the tax increase has crimped sales.

Steve Gates for The Wall Street Journal

Rick Casey, shown with his wife, Courtney, and their children, says he plans to cut back on spending because of the increase in the payroll tax.

Sales figures last month were mixed. A Thomson Reuters report released Thursday showed U.S. retailers' sales growth in January was stronger than last year, but another survey, by Redbook Research, indicated January's sales growth was much weaker.

The tax increase comes at a time when consumers, who account for about two-thirds of demand in the economy, had started showing some muscle. Home buying has revived, and car sales have revved. It is possible that after the initial shock of a tax increase sinks in, consumers will just dig deeper into savings to keep spending. People also are borrowing more, but through student and auto loans, not credit cards. That suggests they remain uncomfortable about taking on debt.

The tax holiday—aimed at boosting the economy early in the recovery—shaved a worker's share of the Social Security tax to 4.2% from 6.2% in 2011 and 2012. The TaxPolicyCenter, a joint venture of the Brookings Institution and the Urban Institute, estimates that gave households on average an extra $900 to $1,000 a year.

The end of the tax holiday comes as Americans shell out more for gasoline. Gas prices have jumped 7% this year, to $3.54 per gallon on average, which further erodes households' spending power.

Rick Casey, a software developer in Birmingham, Ala., is among those scaling back spending as a result of the tax change. The 34-year-old and his wife spent more on groceries and restaurants in recent years partly because they were getting around $150 more a month, he says. In August, they bought a new Toyota Highlander. Mr. Casey is the family's sole breadwinner, making just over $100,000, while his wife cares for their three young children.

Mr. Casey says that in the past he used tax breaks and other windfalls to pay off debt or increase savings. But with the payroll tax holiday, probably because it came in small increments, he says he just spent a little more each month.

Now he says he is planning to cut back, by eating out less, canceling his satellite-TV subscription and postponing bathroom remodeling. "We'll budget around it," Mr. Casey says.

Dean Maki, an economist at Barclays Capital, expects spending, adjusted for inflation, to grow only 1.5% on an annualized basis in the first quarter, compared with a 2.2% pace late last year. Cutbacks also might not come for months, possibly even into the second quarter, Mr. Maki said. "Consumers typically react to changes with a lag," he says.

Bank of America Merrill Lynch economists said many Americans will have to spend less because they don't have the resources that would enable them to maintain their spending levels after the bigger tax bite. "About half of Americans have very low financial savings," economist Ethan Harris says.

Some businesses say they have already seen consumers cutting back. Wesley Idol III, owner of Pacific Dining Car, an upscale steak house in Los Angeles, says sales last month were the worst since 2008. "Consumers are trading down," Mr. Idol says. "Economies are driven by confidence, or lack thereof, and all the news about these current taxes" have hurt consumer sentiment, he says. Mr. Idol recently introduced a less costly late-night menu.

A survey of consumer confidence by the University of Michigan last week showed Americans getting more optimistic in January—though most of the improvement reflected rising confidence among higher-earning Americans, not lower-paid workers who are hit hardest by the tax increase. Another major gauge of consumer sentiment, assembled by the Conference Board, showed consumer confidence fell last month to the lowest level since November 2011.

Brady Miller, a general contractor in Mossville, Ill., is concerned about the impact of losing roughly $1,200 a year—as well as the blow to consumers who are the customers for his home-building business. He notes the tax holiday was in place for two years, "so people's spending habits changed, and so they're getting dinged again." Mr. Miller says his own family will steer clear of buying any big-ticket items this year.

Adjusting will be harder for Americans with lower incomes like the four carpenters Mr. Miller employs. One employee told him the $20 less a week is forcing his family to forgo eating out and going to the movies. "It's going to have an effect," Mr. Miller says. "Twenty dollars seems small, but when a lot of people are spending less, it makes a difference."

Write to Neil Shah at