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Tax Bite Curbs U.S. Growth Along With Consumer Spending

Photographer: David McNew/Getty Images

Households cut back on travel, legal services and personal care expenditures and also curbed spending on health care. Close

Households cut back on travel, legal services and personal care expenditures and also... Read More

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Photographer: David McNew/Getty Images

Households cut back on travel, legal services and personal care expenditures and also curbed spending on health care.

Growth in the world’s largest economy was less than originally estimated in the first quarter as an increase in the U.S. payroll tax took a bigger bite out of consumer spending than previously calculated.

Gross domestic product grew at a 1.8 percent annualized rate from January through March, down from a prior reading of 2.4 percent, Commerce Department data showed today in Washington. Household purchases were trimmed to a 2.6 percent advance -- still the fastest in two years -- from the 3.4 percent gain estimated last month.

Americans cut back on services from vacations to legal advice as the two percentage-point increase in the payroll tax caused incomes to drop by the most in more than four years. At the same time, an improving labor market and rising home prices are underpinning consumer confidence, one reason economists project growth will pick up in the second half of the year.

“You’re not seeing a big pullback in consumer spending, it is just weaker than previously estimated,” said Daniel Silver, an economist at JPMorgan Chase & Co. in New York. “The housing recovery will continue to push forward. Overall growth is going to be stronger in the second half.”

Stocks and Treasury securities rallied on speculation the weaker-than-projected growth reading will prompt Federal Reserve policy makers to delay reducing bond purchases. The Standard & Poor’s 500 Index rose 1 percent to 1,603.26 at the close in New York. The yield on the benchmark 10-year note fell to 2.54 percent from 2.61 percent late yesterday.

Financial System

Elsewhere, the Bank of England today said lenders are vulnerable to an abrupt increase in long-term interest rates as it warned confidence in the financial system remains fragile. The central bank ordered a review of banks’ exposure to interest-rate risk, which it said is not properly understood.

The U.S. government’s GDP estimate is the third and final one for the quarter. The 0.6 percentage-point reduction was the biggest for a final reading of GDP since the figure for the third quarter of 2009, which was lowered by the same amount.

The median forecast of 82 economists surveyed by Bloomberg called for a 2.4 percent rise in first-quarter GDP, the same as the Commerce Department previously estimated. The economy grew at a 0.4 percent pace in the last three months of 2012.

The downward revision was centered in consumer spending on services, with the updated figures showing a 1.7 percent gain compared with a prior estimate of 3.1 percent. Outlays in the category that includes tourism, legal help and personal care items such as haircuts, dropped in the first quarter from the previous three months. Spending on health-care services grew at a slower pace than previously projected.

‘Moderate Pace’

“All in all, things are improving, but there are a lot of negatives still weighing on the economy,” said Joshua Shapiro, chief U.S. economist at Maria Fiorini Ramirez Inc. in New York. MFR was the best U.S.-based forecaster of the economy in the past two years, according to data compiled by Bloomberg. “Consumer spending is growing at a moderate pace.”

While gains in property and share prices are helping more affluent Americans, Shapiro said, “we also have a huge swath of the population living paycheck to paycheck, and they’re feeling the pinch.”

The payroll tax paid by all workers reverted to its 2010 rate of 6.2 percent in January after holding at 4.2 percent for two years, costing households that earn $50,000 a year about $80 per month.

Spending Cuts

Another round of fiscal tightening started taking effect in March with the $85 billion in automatic across-the-board federal spending cuts known as sequestration.

Given the restraints, growth will cool to a 1.7 percent pace this quarter before advancing at an average 2.5 percent rate in the second half of 2013, according to the median forecast of economists surveyed by Bloomberg this month. The economy will grow 2.2 percent in the fourth quarter of this year from the same three months in 2012, the projections showed.

Fed growth forecasts are more optimistic: policy makers project the increase this year will be in the range of 2.3 percent to 2.6 percent, according to projections issued last week.

For the Fed’s outlook to come to pass, GDP would have to expand at about a 3.3 percent average annual rate in the last six months of 2013, according to calculations by economists at BNP Paribas SA in New York.

“It will be really hard for the economy to achieve such a robust pace in the second half,” said Yelena Shulyatyeva, a BNP Paribas economist. “That’s quite an aggressive assumption.”

Bernanke’s View

The central bank may taper its monthly bond buying later in 2013 and halt purchases around mid-2014 as long as the economy performs in line with its projections, Chairman Ben S. Bernanke told reporters on June 19 after policy makers’ two-day meeting.

“If the incoming data support the view that the economy is able to sustain a reasonable cruising speed, we will ease the pressure on the accelerator by gradually reducing the pace of purchases,” Bernanke said at the press conference in Washington. “However, any need to consider applying the brakes by raising short-term rates is still far in the future.”

The rebound in housing is one reason policy makers are more upbeat. Values of existing properties in 20 U.S. cities in April posted the biggest year-over-year gain since March 2006, according to S&P/Case-Shiller data issued yesterday. Rising home prices will help boost Americans’ wealth and buying power.

Sales of new houses in May climbed to the highest level in almost five years, a Commerce Department report also showed yesterday.

Scotch Tape

Businesses such as 3M Co. (MMM), a St. Paul, Minnesota-based manufacturer, are among those benefiting. Consumers are spending on home improvement in addition to purchases of products such as Post-it Notes and Scotch Tape, according to Chief Financial Officer David Meline.

“We do expect some modest improvement as we go through the year based on a view that the economy is going to continuously show some improving resilience,” Meline said at a June 12 conference.

The automobile industry also continues to be a bright spot as May sales indicated it is on course for the best year since 2007, which in turn is encouraging automakers to invest and hire. Ford Motor Co. (F) said it is adding 2,000 workers and a third shift at its F-150 factory in Missouri to increase production of pickups beginning in the third quarter.

To contact the reporter on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net

To contact the editor responsible for this story: Christopher Wellisz in Washington at cwellisz@bloomberg.net

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