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Big Payroll Tax Hike Bites Amid Record Wage Slump

Higher payroll tax rates this year will make a record wage slump feel even worse, as Americans struggle with stagnant pay in addition to a weak job market.

Yearly wage growth for production workers and nonsupervisors has been below 2% for 17 straight months, less than the rate of inflation. The prior longest streak was just four months. From May to November, growth was below 1.5%.

Adjusted for inflation, average wages have fallen annually for 21 of the last 23 months. Yet in that time, the economy created jobs at a steady, albeit slow, pace.

"There are employment opportunities, but they don't pay the way they used to," said Anthony Sanders, a finance professor at George Mason University.

Now, a 2-percentage-point increase in payroll taxes that went into effect at the start of this year is cutting most Americans' take-home pay. High earners also face steeper rates on income and capital gains.

Looking at weekly wages, Credit Suisse analysts recently calculated that the payroll tax hike alone would effectively wipe out last year's nominal gains in one month, if January earnings stay at the same level as December.

With the shock to wages hitting hardest early in the year, economists see GDP growth below 2% in Q1 after it likely crawled ahead by less than 2% in Q4.

Workers appear poised to make up for the lost pay mainly by trimming consumption vs. reducing savings.

A survey by RBC Capital Markets showed that 57% plan to reduce spending due to higher payroll taxes, and 25% don't plan to adjust spending. Another 13% weren't sure what they will do, and 5% expect to spend more.

New York Federal Reserve researchers also found consumers in 2011 (when tax cuts previously were to expire) planned to slash spending by 71.4% of the income lost to the higher payroll tax, but only cut savings by 26.1% of the amount and increase debt by 2.4% of it.

The tax hikes come as wages have been under pressure since the 1990s, when an outsourcing wave to China and other emerging markets accelerated. Today, high unemployment is weighing on wages too, with new union jobs in auto plants even paying less.

Government policies are holding wages down as well, said Sanders. Environmental regulations encourage companies to shift work overseas, and firms trying to get around ObamaCare mandates on coverage for full-time workers are hiring part-timers instead.

"We're actually having wage deflation," he said.

Even though China's low-wage advantage is deteriorating enough that some production is returning to the U.S., Sanders doesn't see the outsourcing trend going away. In fact, it could pressure wages in the service sector the way it pressured them in manufacturing.

He points to the growing number of sick and elderly Germans moving to long-term care centers in Eastern Europe and Asia as a sign of what to expect here.

The single biggest factor in weak wages is the labor market collapse, said Michael Hanson, a senior U.S. economist at Bank of America Merrill Lynch.

The loss of construction jobs, for example, wiped out a source of high wages for workers without a college degree. Workers fortunate enough to get hired after an extended period of unemployment often earn less than what they used to make.

Automation and technology are also reducing the need for lower-skill jobs, such as medical and legal work that paid above the average rate.

Competition for any openings has increased too, with laid-off professionals and older people at or near retirement depressing wages.

"That's a phenomenon that's somewhat new to this cycle," Hanson said.