Monday, October 31, 2011

Spending, Transfer Payments, and Taxes

As the chart below shows, personal outlays (i.e. spending) has grown significantly faster than wages over the past decade. Even before the crisis, consumers spent more of what they earned.

Since the 2008 crisis, wages initially declined (and have since remained stagnant) and the level of savings has moved higher (both of which are negative for consumption on a stand-alone basis), but spending remains strong.

How is this possible?

Well, when one adds in transfer payments (i.e. money provided by the government) and subtracts less taxes from wages, we see a different story... growth that has actually outpaced consumption since the downturn.

The reduced tax burden is a result of lower incomes to tax, a lower tax rate via the progressive tax structure, and tax cuts enacted to stimulate demand.

Telling (to me) is that over the last 10 years, wages plus transfer payments less taxes have grown at pretty much the exact same rate as personal outlays, despite weak wage growth. Going forward, unless there is change in the austerity sentiment that has been the focus of both Republicans (less spending) and Democrats (higher taxes), expect the boosts we have seen, to soften.

If that happens, we'll likely need actual wage growth via an employment recovery in order for the consumption rebound to continue.

Source: BEA