Economic Recovery and Government & Economic Development and Government and Economic Development

Tax cut lifts incomes, but spending barely rises

February 28, 2011

A tax cut that began last month gave consumers the biggest jump in their incomes in nearly two years. But Americans boosted their spending only slightly, a sign that many people are being cautious with their money even as the economy improves.

Consumers increased spending 0.2 percent in January, the smallest gain since June, the Commerce Department reported Monday. Personal incomes jumped 1 percent, reflecting the 2 percentage point reduction from the Social Security tax cut.

The small spending gain pushed total spending last month to an annual rate of $10.59 trillion, up 7.4 percent from the recession low hit in December 2008. Economists are counting on spending to increase throughout the year, which would help the economy grow.

The latest survey by the National Association for Business Economics released Monday predicted consumer spending will rise 3.2 percent this year, up significantly from the actual spending gain of 1.8 percent in 2010.

The Social Security tax cut will give the typical family an extra $1,000 to spend this year. But the recent surge in gasoline prices has raised worries that consumers may need to spend the extra money on fuel, and not new goods and services.

The big rise in incomes and small increase in spending meant that the personal savings rate rose in January. Households saved 5.8 percent of their after-tax incomes, up from 5.4 percent in December. For all of 2010, the savings rate was 5.8 percent. That's down slightly from 5.9 percent in 2009. But it is well above the 2.1-percent savings rate in 2007, when Americans were spending freely as the value of their homes surged to record levels.

Since the housing bust and steep recession, Americans have been more cautious. The savings rate has more than doubled from the 2007 level. The effort to increase savings has acted as a drag on consumer spending. But economists say it should result in stronger spending in the future after consumers pay down debt and boost their savings enough to feel more secure.

Economists closely watch consumer spending because it accounts for 70 percent of economic activity.

In the final three months of 2010, the overall economy grew at an annual rate of 2.8 percent, the government reported Friday.

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