Tax Cut Boosts Incomes, Spending Sees Small Gain

February 28, 2011 - 3:31 PM

Washington (AP) - 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. Some economists said that poor weather may have played a role in slowing spending growth last month. They are counting on spending to increase throughout the year, which would help the economy grow.

Separately, the National Association of Realtors said fewer people signed contracts to purchase homes in January, the latest evidence that the housing market is struggling. The trade group said its index of sales agreements for previously occupied homes fell 2.8 percent last month to a reading of 89.9.

That's higher than the 75.9 reading from June, the low point since the housing bust. But it's below 100, which is considered a healthy level. The last time it reached that point was in April, the final month people could qualify for a home-buying tax credit.

Consumer spending was growing at the fastest pace in four years in the final three months of 2010, helping to support the overall economy. But the weak showing in January raised questions about how strong spending will be going forward.

The modest 0.2 percent rise in spending was even weaker when inflation was taken into account. After adjusting for price changes - particularly a steep rise in energy costs - spending actually dipped 0.1 percent in January. That was the poorest showing since inflation-adjusted spending had fallen 0.8 percent in September 2009.

"Overall we expect consumption to be fairly strong in the first half of the year. But the way things are going at the moment, all the payroll tax cut will do is offset the rise in gasoline and food prices, rather than provide a boost to real spending," said Paul Dales, senior economist at Capital Economics.

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.

For January, consumers boosted spending on durable goods, items like new cars, and on nondurable goods such as food and gasoline. But they trimmed spending on services.

The 1 percent rise in incomes in January would have been a much more modest 0.1 percent gain if the effects of the tax changes had been excluded.

The 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.