Effect of Payroll Tax Reduction on Lodging

1.5 Million more jobs will likely result in greater lodging demand and raised hotel profits from the newly passed tax plan. 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 (“PKF-HR”) 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 their 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 new tax plan by the Obama administration includes provisions that not only extends the current tax rates, but also introduces a payroll tax reduction of 2.0 percent of wages, effective January 1, 2011. According to Moody’s Analytics, this provision alone could boost consumer spending by upwards of $120 billion. While the continuation of the existing tax rates was largely expected and was incorporated by Moody’s in their previous U.S. forecasts, the payroll tax reduction proposal, which effectively would give the vast majority of working Americans a 2.0 percent pay raise, took many macro economists 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, 2011, Moody’s estimates that the increase in GDP of 4.0 percent (up from a pre-proposal forecast of 2.8 percent) 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 table below outlines how lodging performance in 2011 could be impacted when employment taxes are reduced from 6.2 percent to 4.2 percent on January 1, 2011. 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 average daily room rate forecast increase of 3.9 percent improves to 4.6 percent.

These higher occupancy and average daily rate levels would yield a 280 bps improvement over the already attractive 6.2 percent increase in revenue per available room (RevPAR), in the expected case scenario. The expected 11.1 percent lift in Net Operating Income for the typical U.S. hotel would expand to 16.0 percent when the employment tax reduction becomes law January 1, 2011.

Conclusion

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.

About the author: R. Mark Woodworth is president of Colliers PKF Hospitality Research and is based in Atlanta. Please visit for more information on PKF-HR’s Hotel Horizons forecast reports. This analysis was first presented on a conference call with the clients of Credit Suisse on Monday, December 13, 2010.

photo of Robert Mandelbaum