Inside the payroll tax holiday and just how to experience a happy one

A 2 percent increase might be inside your near future if the payroll tax holiday passes within the Bush tax cut offer. Legislators regard a payroll tax holiday as a way to stimulate the economy. The idea is that consumers will invest the additional income. Monetary theory, however, may suggest that that cash could be saved or invested instead. If all goes as planned, people should have less of a have to get a pay day loan.

Economic predictions up for 2011 with payroll tax holiday

The payroll tax holiday proposal rolls back the employees’ share of the payroll tax from 6.2 % to 4.2 percent on income up to $106,000. Announcing the tax deal gave firms like Deutche Bank a reason to change 2011 economic growth predictions. They went from 3.3 percent to 4.1 percent as a result of this. This is the math behind it all:

Wages and salaries in the U.S. in 2010 total $6.44 trillion. That figure grew nearly 5 percent in the second and third quarter. If that rate continues, wages and salaries will total about $6.75 trillion a year from now. Deutche Bank estimates about 85 % of total wages and salaries are dinged by the payroll tax. A 2 percent reduction in that tax puts $115 billion back in workers’ wallets. Based on the current personal savings rate of 5.8 percent, $108 billion — 0.7 percent of estimated 2011 GDP — would be spent. Therefore, 3.3 + 0.7 = 4.1 percent.

What the Permanent Income Hypothesis really means

Some believe Deutche Bank is overly optimistic. John Carney at CNBC writes that the payroll tax holiday won’t increase spending nearly that much because informed consumers will realize their 2 % raise is only temporary. Economists call this the Permanent Income Hypothesis. Future earnings are what people spend based upon off of. Current take-home pay doesn't do that. The financial crisis changed people. Before it, people spent more than they earned and wouldn't conserve at all. Then the bottom fell out. Now people spend less and save more because expectations for the future are diminished.

What you are able to do with your payroll tax holiday

The payroll tax holiday is exciting as additional money. What should be done with it? If you don’t run out and spend it, SmartMoney suggests putting that 2 % raise into a 401(k), a traditional IRA or a Roth IRA. The money will then be worth something. It will still be worth something after 2012 when the payroll tax holiday ends. Health care costs are expected to go up next year, so saving now to cover those increases is an option. Buying new appliances is a new option. You could save hundreds of dollars in a few years with more energy efficient home appliances.

Articles cited

SmartMoney

smartmoney.com/personal-finance/taxes/what-to-do-with-a-payroll-tax-cut/#ixzz17WrUvmtU

CNBC

cnbc.com/id/40553481

Business Insider

businessinsider.com/deutsche-bank-explains-why-the-payroll-tax-holiday-is-a-game-changer-and-could-push-gdp-to-41-2010-12