Danger Ahead: 3 Sectors that Should Brace for the Fiscal Cliff

By IBISWorld Senior Industry Analyst Nikoleta Panteva

Not without good reason has the term “fiscal cliff” been the buzzword of post-election 2012. After experiencing tax cuts in 2001, 2003 and 2009, Americans are now faced with the impending expiration of more than 80 payroll and income tax breaks if Congress fails to reach a budget deal by the end of 2012. The measures would be aimed at lowering the federal government’s deficit, which has exceeded $1 trillion in each of the past four years. About two-thirds of the proposed revenue-generating policies is based on taxes, a hot topic that has erected an impasse in Washington. The expirations could bump up the average household’s income tax rate by about five percentage points, according to the Tax Policy Center. Some households, particularly those that file jointly and earn between $60,350 and $72,350, may even be looking at as much as a 13 percentage point increase in 2013. Without a doubt, nearly all Americans will see the effects of the fiscal cliff in their wallets. A complete elimination of recent tax cuts could lead the nation to a double-dip recession, as consumers significantly reduce their spending and create a drag on GDP. In the event that an alternative does not emerge, IBISWorld has examined the potential impact that the fiscal cliff would have on the nation’s economy, particularly focusing on tax cut expirations and their effects on specific US industries.

Any increase (or cut reversal) in taxes results in a decrease in per capita disposable income. Disposable income is calculated by taking income earned from all sources (e.g. wages, investment income and government payments), and subtracting taxes, savings and non-taxable payments (e.g. donations). Per capita disposable income determines an individual’s ability to purchase goods and services. When disposable income declines, nonessential items, such as entertainment, travel and fashion apparel, are the first to be cut from a household’s budget. Industries producing or selling nonessential products or services are highly sensitive to changes in per capita disposable income, meaning that a small decrease in income results in a disproportionately large drop in industry revenue. This sensitivity to disposable income translates to high revenue volatility within the sector. By tracking industry performance during the past five years and benchmarking sectors’ revenue volatility against changes in per capita disposable income, IBISWorld has determined the three sectors that will be most severely hurt by the tax increases resulting from the looming fiscal cliff and its likely chokehold on disposable income.

Automotive

Cars are highly discretionary and expensive purchases that require significant maintenance, so a reduction in disposable income would force consumers to delay new purchases over the next couple of years. As such, industries operating in the automotive sector that are particularly sensitive to changes in personal income include car dealerships, gas stations and car service providers (e.g. Car Wash & Auto Detailing). During the five years to 2012, this sector has endured an aggregate 3.1% average annual decline in revenue due to the luckless combination of falling disposable incomes and increasing prices. In 2008, sector revenue plunged 7.1% when the world price of crude oil shot up more than 35.0%. Although in 2009 the price of oil came back down, sector revenue continued to plummet as per capita disposable income dropped 3.6%.

The automotive sector’s high sensitivity to consumers’ purchasing power ultimately resulted in high revenue volatility during the past five years. Based on the sector’s recent performance, IBISWorld expects it to be one of the US economy’s worst-hit victims if the fiscal cliff is not resolved by the end of 2012. This, on top of already-high and volatile gas prices, could severely hurt the auto sector during the five years to 2017.

Apparel

The apparel retailing sector of the US economy is also projected to suffer if the tax cuts get repealed at the onset of 2013. Since 2007, revenue for this sector (which includes Women’s Clothing Stores; Shoe Stores; and Department Stores; among others) has declined at an average annual rate of 2.3% due to declining disposable income and, consequently, falling demand. Its revenue volatility has been slightly less drastic than that of the auto sector, but still highlights the segment’s dramatic annual fluctuations. In 2008, 2009 and 2010, revenue declined by 6.7%, 5.7% and 0.5%, respectively, reflecting consumers’ unwillingness to part with their limited funds for nonessential clothing. If consumers again lose their impetus and financial capacity to shop for clothing due to the expiration of tax cuts under the fiscal cliff, industries in this sector, especially those supplying high-end and high-priced clothing, will suffer in the next year. By contrast, those selling essential items, like babies’ and children’s clothes, will be less affected because demand for these items is based more on need rather than keeping up with trends.

Entertainment

Entertainment is another area that is highly sensitive to fluctuations in consumer spending power. Included in this sector are industries such as Museums, Casino Hotels and Golf Courses and Country Clubs. Because many of these activities are luxuries rather than necessities, consumers are quick to cut them out of their budgets once per capita disposable income begins to decline. As a result, this sector’s revenue has shrunk at an average annual rate of 0.1% during the past five years – a rate the masks dramatic fluctuations over the period. Highlighting its widely perceived nonessential nature, sector revenue was declining in 2008 even before disposable incomes dropped, due to crashing consumer confidence. A rebound in consumer spending power has not completely revived this economic segment, which foreshadows its deep potential drop if tax breaks are not revived at the end of 2012.

Uncertain road ahead

If the effects of low disposable income during the Great Recession are any indication of what the fiscal cliff has in store, these sectors should start bracing for some major challenges in the years ahead. With recessionary struggles still fresh in the mind of many Americans, this blow to disposable income is all it will take to send consumer sentiment cashing again. Should tax rates increase by 5.0 percentage points for the average household, and even up to 13.0 percentage points for some, budgets will tighten and demand for nonessential products will fall. While the reach of the fiscal cliff would go beyond the sectors outlined above, its impact would be especially detrimental to businesses operating within these segments due to their sensitivity to household disposable income and poor performance during the recession. This, however, all depends on whether or not Congress and President Obama can reach a viable agreement that will prevent the expiration of several tax breaks that were initiated during the past decade.

To download full research reports for the industries discussed in this article, click on the report titles below.

New Car Dealers, Used Car Dealers, Gas Stations, Gas Stations with Convenience Stores, Wash & Auto Detailing, Women’s Clothing Store, Men's Clothing Stores, Children's and Infants' Clothing Stores, Shoe Store, Department Stores, Museums, Casino Hotels and Golf Courses and Country Clubs

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