Tax Cuts Boost Americans' Incomes in January

Americans' incomes jumped 1.0% in January, according to the Bureau of Economic Analysis. That's the biggest increase in a single month since May 2009. Consumption also rose, but by a modest 0.2%. Making for a trifecta, savings also increased for the first time in five months. What made January such a great month? The primary factor was tax cuts.

First, here's the chart for income and consumption:

income spending 2011-01.png

It's pretty easy to see the giant leap that personal income took. According to the BEA this was due in large part to the tax cut passed in December reducing the social security tax taken out of Americans' paychecks. That change accounted for about 70% of the 1.0% increase in personal income. So without it, personal income would have only risen by about 0.3%.

Something else happened in January that we haven't seen in a while -- personal and disposable incomes diverged significantly. Disposable income only rose by 0.7%. This was also due to a tax change. This time, however, it was an increase. The Making Work Pay Credit expired in 2010, so more disposable income was due in taxes as a result. This boosted taxes by about $38.6 billion, which is not nearly as much as the cut explained above, which increased personal income by $94.9 billion in January.

Although Americans had more income in January, they did not spend all of it. The 0.2% increase in personal consumption expenditures was the smallest since June. Perhaps consumers took a break ramping up their spending after all that holiday shopping. Another explanation for weak spending growth could be the bad weather some parts of the U.S. experienced in January.

When incomes rise faster than spending, generally that's good news for saving. This is pretty clear by looking at the chart:

saving 2011-01.png

Americans' saving rose by 9.1% in January. That ended a streak of shrinking saving rates.* It was also the highest percentage increase in saving since April 2010. The question here is whether this saving was really conscious. Some Americans might not have realized that they got a new tax break in its first month, since it consisted of a little pop in their paycheck due to less money deducted. Perhaps once people grasp that they've got a little more money to spend, it will begin to flow to retailers instead of sitting in their bank accounts.

There are two ways to look at this report for January. On one hand, it appears to be great news. Incomes rose briskly, spending continued to rise modestly, and saving finally began to grow again. On the other hand, the big income jump wasn't due to more business activity, but because the government lowered taxes by increasing the deficit; the decline in spending growth could indicate that Americans are becoming stingy again after the holidays; and the increase in saving could be more accidental than deliberate. Which narrative is correct? We'll have to wait to see how income, spending, and saving trend as 2011 carries on.

* Note: Initially, I had written "savings accounts," instead of "saving rates" which isn't quite right. Saving was still positive during these months, but the rate of saving was declining, instead of increasing. Thanks to a reader for pointing this out.