What Did You Spend Your Tax Cut on?

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Whether you know it or not, the money you earned at work was given a big tax break over the last 16 months. In 2010, a tax cut that slashed payroll taxes by 2 percentage points was signed into law. The tax cut costs $145 billion a year, and saves an average American family about $1,000 a year.

So, what have consumers done with the savings? A group of researchers at the Federal Reserve wanted to find out. In Feb. 2011, they asked a group of workers what they planned to do with their tax-cut savings. In December of the same year, they asked what they actually did with the savings.

Here's what they found:

Plan

Intended use

Actual use

Mostly consume8.8%35%
Mostly save39.8%26%
Mostly pay off debt50.3%36%

Source: Federal Reserve.

A couple points:

  • We don't have great self-control. A lot of people who think they're going to save money end up spending it. Surprise! We're bad at managing money. That's why we're in this mess to begin with.
  • On the other hand, the survey shows one of the downsides of temporary tax cuts: A lot of the money just gets saved (just not as much as was intended). Dig into economic textbooks and you'll find a page on the "permanent income theory." This basically says that people will save, rather than spend, a temporary windfall because they know it's... temporary. People don't like to go back to their old, poor way of living, so they won't blow a windfall on steak and lobster because next week they'll be back to Ramen and carrots, which hurts. That can defeat the purpose of the temporary tax break, which is to get people spending more and stimulate the economy.

Through it all, retailers from Wal-Mart (NYS: WMT) to Tiffany (NYS: TIF) have actually done well over the last few years -- despite a doubling of the unemployment rate, total retail sales have held up nicely. Recession or not, tax cut or not, little gets in the way of Americans and a cash register.

At the time this article was published Fool contributorMorgan Houselowns shares of Wal-Mart. Follow him on Twitter @TMFHousel.Motley Fool newsletter serviceshave recommended creating a diagonal call position in Wal-Mart Stores.Motley Fool newsletter services have recommended shorting Tiffany. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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