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High gas prices soak up much of cash from cut in payroll tax; Fuel spike puts strain on household budgets

Americans are earning and spending more, but a lot of the extra money is going down their gas tanks. Gas prices have drained more than half the extra cash that Americans are getting this year from a cut in Social Security taxes.

Unlike some other kinds of spending, paying more for gas doesn't help the economy much. Most of the money goes overseas, and higher prices leave people with less money to buy appliances, computers, plane tickets and other things that can be postponed.

"When food and gasoline prices are rising, it causes people to hunker down," said Chris G. Christopher Jr., senior economist at IHS Global Insight.

Consumer spending jumped by 0.7 percent last month, and personal incomes rose by 0.3 percent, the Commerce Department said Monday. Both gains reflected the cut of 2 percentage points in the Social Security tax, raising take-home pay.

They also illustrated how higher gas prices are stressing household budgets. After adjusting for inflation, spending rose by just 0.3 percent. After-tax incomes actually fell by 0.1 percent.

The Social Security tax cut will give most households an additional $1,000 to $2,000 this year. In December, when President Obama signed it into law, economists predicted that higher take-home pay would lead to more spending and stronger economic growth.

But gasoline prices have jumped by more than 50 cents a gallon this year. In late December, they hit $3 a gallon for the first time in two years. Last week, they averaged $3.58 nationwide, according to AAA's daily fuel gauge survey.

Mark Zandi, chief economist at Moody's Analytics, has reduced his forecast for 2011 economic growth to 3.5 percent, from 3.9 percent, in part because of gas prices. That would still be better than last year's 2.9 percent growth and the biggest expansion since before the recession.

Still, much of the anticipated benefit from the tax cut will be lost. Christopher estimates that half to two-thirds of the extra cash will ultimately go toward higher gas prices. Food prices have also risen in recent months, he noted.

Higher gas prices generally don't help the economy, even though they force people to spend more. The additional money doesn't go toward making more products in the United States. And it seldom pays for higher salaries or new jobs. It generally ends up going overseas to oil-producing nations.

Most people don't have the luxury of deciding to buy less fuel. They have to get to work. So they spend more on gas and less on other goods and services -- from household purchases to restaurant meals to vacations -- that do more to drive U.S. economic growth.

Those purchasing decisions are critical for the economy because consumer spending accounts for 70 percent of growth.

There's also a psychological factor when gas prices, a consumer necessity, keep rising. Those higher prices tend to rattle consumer confidence. People feel poorer, and they're less likely to spend freely.

Ultimately, less spending can hurt job growth because businesses will feel less confident. Christopher said a rise of just 25 cents a gallon in gas prices, if it persisted for an entire year, could cost the economy 270,000 jobs.

It's probably too early for the impact of higher gas prices to show up in national employment figures. The economy added 192,000 jobs in February. The consensus estimate of analysts is that it added 185,000 in March.

People made big purchases in February. Spending on durable goods rose by 1.7 percent, much of it from new cars. And though in 2010, the housing market had its worst year in a decade, the National Association of Realtors says more people signed contracts to buy homes in February than in January.

Still, economists are lowering expectations for the January-to-March quarter. Paul Dales, senior U.S. economist at Capital Economics, said consumer spending will likely grow only 2 percent to 2.5 percent in that stretch. That would be down sharply from the 4 percent increase in consumer spending in the October-December period, the fastest pace in four years.

The big rise in spending and smaller increase in incomes pushed the household savings rate down to 5.8 percent of after-tax incomes last month. That compared with 6.1 percent in January.

Dennis P. Lockhart, president of the Federal Reserve Bank of Atlanta, said he doesn't expect food and energy prices to keep rising sharply.

"I expect these strongly accelerating upward movements of commodity prices to be short-lived," Lockhart said in a speech Monday in Atlanta.

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