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Payroll tax hike: Killer whale or red herring?

Sunday - 3/3/2013, 3:40pm  ET

DANIEL WAGNER
AP Business Writer

WASHINGTON (AP) -- Companies are rushing to describe the impact of higher Social Security taxes that took effect in January. They paint a bleak picture.

Cash-strapped shoppers are spending less, many U.S. firms warned in earnings announcements over the past few weeks. They are avoiding small luxuries like restaurant meals and fashion items. And they're reconsidering major new purchases. Wherever people chose to cut back, those companies would feel the pinch.

In the past, companies have blamed flu epidemics, earthquakes and SARS for poor results. The trouble, experts and analysts say, is that these high-profile events are only part of the story -- sometimes barely a sliver.

The latest culprit is a 2 percent increase in the Social Security payroll tax, which all U.S. wage earners pay. The rate was reduced temporarily as a measure to boost the economy out of recession, but that "holiday" ended on Dec. 31. As a result, households earning $50,000 will have about $1,000 less to spend this year. A household with two high-paid workers will have up to $4,500 less.

"Any time something like this happens -- whether Hurricane Sandy or the tsunami or the payroll tax hike or uncertainty in Washington -- any company that didn't perform as well as they would have liked gets to say, 'Look, these idiots in Washington are screwing it up for us,'" says Dan Greenhaus, chief global strategist at BTIG, a brokerage firm.

Greenhaus says he is not surprised by the number of companies grousing about payroll taxes. A catchy news hook can help companies "blame a macrotrend for what may be a micro story" about their individual strengths and weaknesses, he says.

There's little doubt that the drop in take-home pay will drag on economic growth. Government economists estimate it will lower economic output 0.6 percent this year.

Yet the tax talk ignores a host of trends, outside events and company-specific factors, analysts say. They say investors should pay closer attention to these factors when considering how a company might perform this year.

Take Darden Restaurants Inc., operator of chains like Olive Garden and Red Lobster. Like other casual sit-down restaurant companies, Darden faces tough competition from chains like Chipotle Mexican Grill and Panera Bread, whose food and prices fall somewhere between fast-food and sit-down fare. Darden's shares slid 28 percent between their recent peak in September and Feb. 21, the day before it lowered its earnings forecast.

But when the weaker forecast was announced, Darden CEO Clarence Otis blamed the payroll tax hike, along with gas prices and winter weather. He said things had looked promising for the restaurant chain in late 2012 until these "difficult macroeconomic headwinds" blew in. Sales dropped because customers had less buying power, Otis said, despite the restaurants' price cuts and promotions.

"They aren't executing as well as their competitors," says Sara Senatore, an analyst at Sanford C. Bernstein who covers the industry.

Fast food diners, generally lower-end than Darden's casual dining clientele, cut spending quickly when taxes rose, said Steve Wiborg, North America president of Burger King Worldwide, on an earnings call last month.

Wal-Mart offered a similar message when it announced earnings, saying its core customers, poor and middle-class Americans, were spending less because of the payroll tax hike, along with higher gas prices and delayed tax refund checks.

Yet Wal-Mart and other discount retailers saw potential benefits from the tax squeeze. Wal-Mart said it is "confident that our low prices will continue to resonate, as families adjust to a reduced paycheck." Dollar Tree executives said last week that their store would provide a welcome alternative for Americans seeking to cut back.

"We're seeing the effect (of the payroll tax hike) on the consumer," said CEO Bob Sasser, "but we think we're part of the solution and a destination for a cash-strapped consumer who's trying to balance their budget."

Discount retailer stocks are rising. The TJX Cos. Inc., operator of T.J. Maxx and Marshalls, is up 6 percent this year, Ross Stores Inc. 7.5 percent and Stein Mart Inc. 16.6 percent. Wal-Mart is up nearly 4 percent since its earnings announcement on Feb. 21, while Burger King has gained more than 9 percent since it unveiled results on Feb. 15.

Like the mid-range retailers and restaurants that can blame their woes on tax policy, lower-end stores may be trumpeting its benefits to them too hastily, says Joesph LaVorgna, chief U.S. economist at Deutsche Bank Securities.

"We don't know much about the first quarter," he said, and retail sales data for recent months have been revised upwards. The tax hike will inevitably hurt consumers in the first quarter, he said, "but that doesn't mean consumer spending is necessarily going to be weak."

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