By Karen Talley 
 

Dollar stores and other retailers catering to lower-income consumers face the greatest risks if the U.S. falls off the fiscal cliff.

Stores targeting the more affluent, meanwhile, would feel little pain as the country grapples with the higher taxes and deep government spending cuts scheduled for Jan. 1 if Washington doesn't agree to a new budget bill.

If the payroll tax cuts put in place in late 2010 are allowed to expire at the end of the year, Morgan Stanley says retailers like Dollar General Corp. (DG), Dollar Tree Inc. (DLTR) and Family Dollar Stores Inc. (FDO) could face a drop of 1% to 2% in comparable-store sales and a six cents to 10 cents a share loss in earnings per share in 2013.

"We estimate the payroll taxes deduction would decrease discretionary spending capability by 6% for those that make less than $40,000," Morgan Stanley said. "As most households at this level spend all that is available to them, this should directly come out of discretionary spending."

Lower-income consumers who frequent stores like Family Dollar and Wal-Mart Stores Inc. (WMT) often live paycheck-to-paycheck and would have less money for essentials and discretionary purchases.

The threat prompted Wal-Mart Chief Executive Mike Duke to urge Washington to act before the end of the year.

"In many ways, Wal-Mart's customers are at the center of this debate," Mr. Duke said in a statement after he and other business leaders met recently with President Barack Obama. "They are middle-class Americans and those aspiring to join the middle class. If the White House and Congress can reach agreement, it will show them the nation's leaders can address big issues, and it will help raise their confidence in their government and their future."

In its third-quarter earnings report, Dollar Tree in part blamed the fiscal cliff for consumers pulling back on spending. Family Dollar has said middle-income spenders would likely be trading down, noting that sales for more discretionary items like new clothing could suffer.

Morgan Stanley also expects off-price retailers like TJX Cos. (TJX) and Ross Stores Inc. (ROST) to feel an impact given their general exposure to lower-income consumers. Teen retailers like Aeropostale Inc. (ARO) and Abercrombie & Fitch Co. (ANF) also could be hurt because many of their young shoppers receive spending money from their parents.

For upper-income consumers, the impact of higher taxes would be less acute, an estimated 2% decrease in discretionary spending, Morgan Stanley said. Women's apparel retailers like Ann Inc. (ANN) and Chicos FAS Inc. (CHS), as well as upscale retailers including Coach Inc. (COH), Nordstrom Inc. (JWN), Saks Inc. (SKS) and Tiffany & Co. (TIF) are likely to see little to no impact, the bank said.

Federal lawmakers are grappling with the fiscal cliff, a $500 billion package of spending cuts and tax increases that will go into effect unless the White House and Congress negotiate an alternative. If policy makers don't act before the end of the year, the Congressional Budget Office said the economy would contract by 0.5% next year, and the unemployment rate would jump from 7.7% to 9.1%.

"We're finally getting to a point where people are coming back," said Tom Duncan, chief executive of Positec Tool Corp., a powertool maker that sells through Home Depot Inc. (HD), Wal-Mart and Lowe's Cos. (LOW). "The biggest fear by companies like us and retailers is that it is going to be cut short."

Carl Steidtmann, chief economist at Deloitte, estimates that at least $341 billion in spending power will be lost with the extra payroll taxes, the loss of the Bush tax cuts and the discontinuation of long-term unemployment benefits. "People will be forced to cut back their spending, and that means a lot of retail," Mr. Steidtmann said.

Write to Karen Talley at karen.talley@dowjones.com

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