Mapping the tax reform impact on US consumer income and spending.
US tax reform is already affecting post-tax income of households across the nation, although the direction and magnitude vary widely across income brackets, states and filing status. CFOs and CMOs must understand how these tax changes may affect their companies’ target audiences’ spending patterns, quantify this impact on different parts of their business and adjust their operations accordingly.
What is the impact of US fiscal reform across various types of consumers? How can companies capture market growth? Where may consumer demand rise and how can companies mitigate the risk where demand may fall as consumers adjust their budgeting decisions?
Some of the most impactful measures in the law related to individual income tax are:
- A modification of the income levels of tax brackets and a reduction of tax rates across brackets
- A near doubling of the standard deduction, which more filers are likely to utilize under the new law
- A $10,000 cap on the state and local taxes (SALT) deduction, mostly selected by high-income households filing in high-tax states
While most US households will see a net increase in post-tax income, a small portion of households will see their tax bill go up. Due to the SALT cap, these households, whose net income will decline, are generally high-income and file in high-income or property tax states (e.g., California, Connecticut, Illinois, Massachusetts, New York, New Jersey and Washington, DC).
It is well-known that a change in consumers’ income will directly impact spending decisions across industries. The extent of the impact, however, will vary across both consumer segments and product categories. For instance, as suggested by US saving rates across different income categories,1 higher-income households have higher savings rates and so are more likely to allocate an income increase to savings rather than spending. Other populations may fully spend that extra cash or use it to pay off debt. The products and services that consumers will likely shift spending toward or away from also vary across demographic characteristics.2
Low-income households are more likely to spend an income increase on small discretionary items, including food or entertainment. High-income households negatively impacted by the reform are likely to cut back on discretionary durables or tourism and leisure expenses.
The complexity of predicting consumers’ budgeting decisions
Not only will the tax reform shift income and budgeting decisions across different populations in different ways, the impact will also vary across categories of consumer products and services.
So how can companies systematically quantify the impact of US tax reform on their consumers’ spending decisions?
In order to anticipate how demand will shift, businesses should classify products in their portfolio considering two factors:
- The income elasticity of demand for the product
- The degree to which demand for the product is concentrated in populations likely to see their income affected by the tax law
When determining demand income elasticity, consumer goods can be divided into three categories:
- Inferior goods: demand for these goods decreases as income rises, allowing consumers to switch to higher-quality substitutes. Margarine is an example of an inferior good.
- Necessity goods: their demand rises with income, but growth is lower than that of income. Most consumer staples fall under this category.
- Superior goods: demand for these goods increases more than proportionally as income rises. Luxury goods are examples of superior goods.
Below are the products and industries that we expect to be most impacted by the reform based on their demand elasticity and the degree to which demand is concentrated in groups most likely to be affected by the tax law.
Positive elasticity and customer base positively affected:
- Discretionary nondurables
- Premium retail
- Health and wellness
Positive elasticity and customer base negatively affected:
- Big-ticket items
- Luxury auto
- Luxury leisure
Negative elasticity and customer base positively affected:
- Discount stores
- Off-price department stores
- Certain fast-food categories
How companies should prepare for demand shifts
As US households start to adjust their budgets following tax reform, CFOs and CMOs should evaluate whether their industry, portions of their product portfolios or specific customer segments are particularly affected. And they should consider taking the following initiatives:
- Supply chain: adjust production, inventory management and distribution strategy to accommodate the new levels of demand
- Marketing: reassess the marketing strategies in place to either engage customers likely to cut their spending or attract new customer segments; provide customer relationship management capabilities, including identification of income-related purchasing behavior changes and identification of customer segments by level of income elasticity
- Merchandising and assortment of products and services offered: reassess product offering and assortments locally based on expected shifts in local demand across customer segments
- Pricing and promotion or discounts: review pricing and incentive strategy in light of shifts in demand across customer segments to either maintain customers likely to switch to different categories of products or attract new customers; anticipate increases in incentive budget for additional market support
- Investment and strategic actions: assess whether the business should target new customer segments, understand how those segments compare to the current customer base and assess whether the current product portfolio meets the new demand
- Innovation pipeline: review current product innovation strategies and anticipate innovation in products and services to meet that demand
Taking the appropriate actions requires a thorough understanding of the economic impact of the tax reform on different populations and of consumers’ spending behaviors across different categories of products and services.