Reduced Tax Refunds Add to Recovery Woes

Battered by storms, starved for jobs and slowed by doubts about White House policies, the U.S. economic recovery is smacking into yet another obstacle: Many households, denied the usual windfall of a tax refund, are pulling back their spending.

“From clothing to appliances to automobiles to household furnishings,” retailers will feel the pinch, predicts Mark M. Zandi, an economist with Regional Financial Associates in West Chester, Pa.

A consumer slowdown by hard-pressed taxpayers threatens to knock as much as one percentage point off the pace of the recovery this spring, said David C. Munro, an economist with High Frequency Economics, a New York consulting firm. In perspective, the economy’s entire growth rate between January and March was just 1.8%.

In fact, the troubles of taxpayers already are chipping away at the economy’s vital statistics.

On Thursday some of the nation’s largest retailers reported lukewarm sales in April, a performance that many analysts believed was influenced in part by tax realities.

The refund factor is just the latest problem for an economy that has slowed markedly from its brisk 4.7% pace in the final three months of 1992.

In the last several days, the government said that the index of leading indicators, its chief forecasting tool, slid sharply in March, and that economic growth slowed dramatically in the first three months of this year. Other evidence, including gauges of consumer confidence and corporate purchasing plans, has been downbeat.

The view is not of a dying U.S. recovery. Rather it is of one that has failed to take flight in the manner of past upturns.

“Spending is going to improve--but I don’t see any significant snapback that’s going to gladden the hearts of retailers,” warns Richard B. Berner, chief economist at Mellon Bank in Pittsburgh, Pa.

The reason: Fundamental problems continue to plague the economy. A meager jobs outlook hangs like a shadow over consumer attitudes and the ability of households to spend. Overseas downturns will limit the ability of foreign customers to buy U.S. goods in the coming months, and weakness in real estate continues to damage many regional economies in the United States, including Southern California.

On top of that, business executives and investors wonder about impending White House policies affecting regulation and taxes. And continued signs of a chilly economy play right into President Clinton’s argument that a multibillion-dollar stimulus is needed, despite the expense.

“At the very least I think it’s making people hesitate, in terms of their hiring plans and so forth,” Berner maintained of the unknowns about the Clinton Administration.

For the short run, however, cash-poor taxpayers stand out as one of the economy’s soft spots, with the fallout likely to be concentrated in the next few months. And that issue leads back to the trouble with taxes.

“I think it’s a strong reason to believe there will be a noticeable tapping on the brakes of consumer spending this quarter,” Munro said.

In dollars and cents, he’s referring to an estimated $10 billion to $20 billion that normally would be in the hands of households this spring that instead will remain with the U.S. Treasury Department.

In large part, the refund story is the legacy of former President George Bush, who sought to fire up the economy last year, before the election, by borrowing some of its vitality from this year. To do it, he ordered a change in the tax withholding tables, modestly boosting paychecks in 1992.

But now it’s pay-back time. As of April 30, the IRS had sent out 3.9 million fewer tax-refund checks--worth a total of $4 billion--than in 1992.

“I saw . . . horror on some people’s faces this year when they saw what their refund was going to be,” recalls Timothy J. Robinson, an accountant with the Jackson Hewitt Tax Service in Los Angeles.

Less dramatically, perhaps, such realities seem to be rippling quietly through the economy.

In March, for example, consumer spending fell for the first time in seven months. The April sales figures for major stores released Thursday, while generally up a bit, disappointed many observers who were looking for signs of a much more solid recovery.

One analyst drew a clear-cut link between beleaguered taxpayers and new signs of lackluster consumer spending.

“All year, people go to Target, K mart and Wal-Mart. Then when you get your windfall from Uncle Sam you go to a more expensive department store and blow it,” said Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis. “That’s not what they did in April.”

Bush’s changes in withholding meant that up to $345 a year might no longer be withheld from a married worker, although the total could climb all the way to $690 for some couples. The reduction in withholding for single workers was about $172.

An analysis by H&R; Block found that the precise figures vary somewhat, but the withholding shifts threw many typical taxpayers from a position of getting a refund to one of owing the government more money.

In the pristine world of economic theory, none of this is supposed to matter very much. People are assumed to be rational creatures whose spending plans are rooted in a clear-eyed assessment of their financial status, not the incidental timing of their tax payments.

Moreover, despite a mountain of real-world evidence to the contrary, people are expected to hang onto as much of their income as possible and invest it--not let the government keep it all year and finally return the money at refund time without interest, as sort of a forced savings.

“Economic theory would say that nobody would use the tax system as a savings club. Yet people do. Lots of people do,” said Donald Ratajczak, an economic forecaster at Georgia State University.

That in mind, analysts now are computing what the reduced number of refunds will mean for an economy peopled by real consumers--not the textbook version.

The general view is that it is an extraordinary, onetime problem that will hit the economy now and fade in the second half of the year.

Economist Zandi forecasts that people will get $15 billion less in refunds this year than in 1992, a hit to their wallets that is strong enough to hijack 0.7 of a percentage point from economic growth in the current, April-June quarter.

David Wyss, an economist at DRI-McGraw in Lexington, Mass., takes a more conservative view, predicting that Americans will get $8 billion less in refunds this year, and that the refund factor will shave half a percentage point off growth in the April-June period.

“It’s not an enormous factor, but it’s enough to depress growth rates,” he said.

Munro suggested that a tax hit of $10 billion, concentrated in the spring months, could cut as much as one percentage point off growth in the current quarter. “Having $10 billion not appear in the income stream this quarter is a big deal,” he maintained.

All of which leads to a final question, one that should--at the very least--intrigue economic historians: For all the headaches it is causing now, did Bush’s shift in withholding help boost the economy last year?

Wyss maintains it did, injecting a shot of adrenaline into the economy last fall, a time when growth started to rally along with consumer confidence. But unfortunately for Bush, the boost was too little, too late. Voters typically render their verdict on a President’s economic performance earlier in the election year, studies have shown.

“If he’d managed to do it six months earlier, his chances would have been better,” Wyss said.

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