The elimination of a 2 percent payroll tax cut, coupled with higher income taxes on the wealthy, will help reduce growth in the first quarter to 1 percent, from 3.1 percent in 2012’s third quarter, the latest data available, according to economists at JPMorgan Chase & Co. and Bank of America Corp. The expansion will strengthen later in the year as the housing market continues to rebound, they forecast.
“It’s going to definitely present a headwind for the economy,” Michael Feroli, chief U.S. economist for JPMorgan Chase in New York, said of the fiscal pact that the Senate planned to vote on early today. “We’re looking for a downdraft in growth in the first half of the year, with the economy coming back in the second.”
The first half slowdown will mean that the U.S. will make limited progress in reducing unemployment in 2013, according to projections by Ethan Harris, co-head of global economic research for Bank of America in New York. He sees the jobless rate falling to 7.5 percent in the fourth quarter of 2013 from 7.7 percent in November 2012.
The agreement forged in talks between Vice President Joe Biden and Senate Minority Leader Mitch McConnell, a Kentucky Republican, would avert some, though not all, of more than $600 billion in automatic tax increases and spending cuts slated to take effect this year. Under the accord, households making less than $450,000 per year would be spared an income tax rate increase. And the unemployed would still be eligible for extended jobless benefits.
Payroll taxes would rise, to 6.2 percent from 4.2 percent last year. And the wealthy would see an increase in their top income tax rate, to 39.6 percent, from 35 percent.
The deal faces an uncertain fate in the Republican- controlled House of Representatives. House Speaker John Boehner of Ohio said last night he would bring any budget legislation passed by the Senate to the House floor.
Even if the measure is passed by the House, the agreement won’t mean the end of budget brinksmanship, Andrew Laperriere, senior managing director for ISI Group in Washington, said in a report yesterday to clients.
The U.S. has hit its $16.4 trillion debt limit, forcing the Treasury Department to take what it called “extraordinary measures” to keep funding the government for now.
The Treasury probably will exhaust such measures by late February or early March, setting up another confrontation between President Barack Obama and congressional Republicans, according to Laperriere, who spent eight years working on Capitol Hill before joining ISI in 1999.
The stock market bounded ahead yesterday as lawmakers looked increasingly likely to reach agreement on the budget. The Standard & Poor’s 500 Index rose 1.7 percent to 1,426.19 at 4 p.m. in New York, bringing the gain for the year to 13 percent.
The biggest hit to the economy from the fiscal package probably will come from the expiration of the payroll tax cut, Feroli said. The payroll tax cut was designed as a temporary measure to boost the economy in 2011 and then was extended through 2012. He reckons that its elimination will slow growth by just over a half percentage point this year by taking $125 billion out of consumers’ pockets.
It “would have a meaningful impact because it hits everybody,” said Michael Gapen, a New York-based senior economist at Barclays Plc. “You’d see it in the first quarter, and consumption would ratchet down.”
Higher taxes on the wealthy, in contrast, won’t have that much of an effect because top earners tend to save more of their income rather than spend it, he added.
Possible federal spending cuts would reduce economic growth by more than a half percentage point if they eventually are implemented, based on estimates by Mark Zandi, chief economist at Moody’s Analytics Inc. in West Chester, Pennsylvania. Defense companies such as Northrop Grumman Corp. and Lockheed Martin Corp. could be particularly hard hit.
The deal would prevent automatic spending cuts from taking effect for two months, Senate Republicans told reporters.
The recovery should prove resilient in the face of government belt-tightening because of the progress that the private sector in rebounding from the 2007-2009 recession, said Bank of America’s Harris.