News & Analysis

No matter how much goes right for the economy — solid job gains, a booming stock market, a mild winter — growth continues to disappoint.
The puzzle can be explained to a large extent by one simple data point: real disposable income.
Year-over-year growth in real disposable income — the earnings Americans have left after taxes and inflation — is stuck below 1%, a level typically associated with recessions. It was just 0.6% in January.
Why has disposable income lagged so badly while job gains in general and private-sector wages in particular are growing at a solid, if not spectacular, rate?
The answer lies in large part in the unwinding of extraordinary government supports. It may seem hard to imagine that fiscal policy is anything but expansionary when deficits remain north of $1 trillion, but the reality is that some of the income props set up a few years ago are going away.
Big Tax Hikes Loom
The upshot: As the private economy finally starts to pick itself up, growth in the larger economy will be muted somewhat. And the drag could get worse, given the tax hikes and spending cuts scheduled to hit in 2013.
Total real private-sector wages rose 3.6% in Q4 vs. a year earlier, Commerce Department data show.
Disposable income was far behind. In fact, the gap between real private wages and disposable income growth has spiked to a near-record 3 percentage points, unheard of this early in a cyclical expansion.
Ebbing government support has acted as a strong undertow since the end of 2010, keeping the economy from gathering a head of steam.
After big increases, government social spending has flat-lined for more than a year, shrinking in real terms, Commerce data show. That social spending includes the big entitlement programs as well as safety net spending on food stamps and jobless benefits.
In Q1 2011, about $20 billion in refundable Making Work Pay tax credits were handed out. But that program expired, so no such payments will be doled out this tax season.
Also, jobless benefits are lower as some recipients exhaust benefits of up to 99 weeks first provided by the 2009 Recovery Act, and other people find work — a good thing.
Medicaid outlays are down too, after federal stimulus to states dried up in mid-2011.
It remains to be seen whether the fiscal drag will continue. There's broad agreement in Washington about the need — but not the way — to tackle the deficit.
It's possible that wage growth could accelerate and overcome such effects.
Other factors are contributing to the drag on disposable income, however.
A big part of the fiscal tightening reflects a typical rebound in personal tax revenue, (mainly income and payroll taxes). Personal tax revenue was up $169 billion from a year ago in January. Those taxes subtract directly from disposable income.
Meanwhile, apart from private wages, other sources of personal income have seen little or no growth.
Public employee wages have been flat in nominal terms for about two years, leaving the private sector to carry the full load.
Finally, interest income has fallen with rates. That has roughly canceled out dividend gains.