Effects of proposed U.S. payroll tax reduction on hotel industry

UNITED STATES A proposed payroll tax reduction under consideration by the U.S. Congress could net 1.5 million more jobs for Americans, resulting in greater lodging demand and profits.

By R. Mark Woodworth, president of Colliers PKF Hospitality Research

After suffering through the all-time worst year of performance in 2009, U.S. hotel owners and operators are eager for growth. The domestic lodging industry has experienced a definite turnaround in 2010. Considering the drags on the economy such as the depressed housing market, high unemployment and federal deficit worries, the swift pace of recovery in the lodging industry has been remarkable. Recently released updated forecasts from Colliers PKF Hospitality Research reveal that a base has been established for very strong gains in both revenue and profits in the years to come. The near-term future could be that much brighter if certain elements of President Obama’s recent tax proposal are enacted into law.

The U.S. lodging industry is highly dependent on the health of the macro economy to sell its products: guestrooms, food and beverage services and meeting rooms. According to preliminary estimates from Moody’s Analytics, the Obama Administration’s recently proposed tax plan has the potential to profoundly affect the state of the U.S. economy in 2011. The Hotel Horizons forecasting models developed by PKF-HR over the past 10 years, which rely on historic and forecast data from Moody’s Analytics, are driven by underlying economic movements to predict the performance of hotels. The econometrically based models rely primarily on changes in real personal income and total payroll employment. The parsimonious quality and explanatory power of these variables relative to changes in lodging demand is significant and far superior to other measures.

The newly proposed tax plan by the Obama Administration includes provisions that not only extend the current tax rates, but also introduce a payroll tax reduction of 2% of wages, effective January 1. According to Moody’s Analytics, this provision alone could boost consumer spending by upwards of US$120 billion. While the continuation of the existing tax rates was largely expected and was incorporated by Moody’s in its previous U.S. forecasts, the payroll tax reduction proposal—which effectively would give the vast majority of working Americans a 2% pay raise—took many macroeconomists by surprise. According to Moody’s Analytics, this additional income would be a boon to consumer spending, which in turn would increase overall domestic production, thus stimulating the need for additional employees. Importantly, while the psychological effects of tax policy certainty over the next year could provide a spending bump (albeit a difficult-to-quantify one), the payroll tax reduction is directly measurable.

Moody’s Analytics cautions that the tax plan is far from complete, and the disparate reactions from both sides of the aisle since the president made his views known clearly shows this plan is a work in progress. However, if the president’s proposal becomes law, effective January 1, Moody’s estimates that the increase in GDP of 4% (up from a pre-proposal forecast of 2.8%) will result in the creation of 2.8 million jobs in 2011 (up from 1.3 million).

The recently-released December 2010 to February 2011 edition of Hotel Horizons (the ‘expected-case scenario’) is based on an employment outlook reflective of the pre-tax plan forecast of 1.3 million jobs added in 2011 and a 2.8% percent increase in GDP. The incremental 1.5 million more jobs than originally expected will stimulate greater levels of corporate and leisure lodging demand nationwide.

The improved economic outlook would lead to a 5.2% increase in demand, 200 bps greater than the current PKF-HR forecast. These additional travelers would allow hoteliers to become even more aggressive with their pricing strategies such that the ADR forecast increase of 3.9% improves to 4.6%. 

These higher occupancy and ADR levels would yield a 280 bps improvement over the already attractive 6.2% increase in RevPAR in the expected case scenario. The expected 11.1% lift in net operating income for the typical U.S. hotel would expand to 16% if the employment tax reduction becomes law January 1.

The short run implications associated with the employment tax reduction component of the president’s plan are significant for the U.S. lodging industry—hotel fundamentals would strengthen at a much quicker rate than would otherwise be the case. The longer-run outlook, however, is not materially different compared to previous expectations. The recovery, which was expected to arrive in 2012, is effectively shifted one year earlier by this fiscal action. Most importantly, expectations for attractive industry growth over the next three to four years remain firm.