The previous post discussed the recent upturn in the personal saving rate and the prospects that it will head even higher as the economy emerges from recession. In light of the recent increase in the saving rate, the following chart, which plots personal consumption expenditures as a share of gross domestic product, may seem anomalous.
From the end 1981 to mid-2003, consumption’s share of GDP increased from 62 percent to 70 percent. Over the same period, the the saving rate fell from 12 percent to 1 percent. It makes sense that the increase in consumption’s share of GDP over this long period should be matched by an almost equal decline in the saving rate. In the last year and one half, however, while the saving rate has increased from 1 percent to 5 percent, consumption’s share of GDP actually increased slightly. How could this happen?
The next chart provides an explanation. The saving rate is conventionally defined as personal saving divided by disposable personal income, which is equal to personal income less current personal tax payments. It was this definition of the saving rate that was used in the previous post’s charts. An alternate saving rate can be constructed by dividing personal saving by personal income, that ratio has been plotted on the following chart.
On this chart we have also plotted personal current taxes as a share of personal income. From the beginning of 1993 to the end of 2000, personal current taxes increased from 11.2 percent of personal income to 14.1 percent. The dot-com recession combined with the Bush tax cuts to reduce personal current taxes share to 10 percent in mid-2003. During the subsequent economic expansion, the personal current tax share recovered, reaching 12.6 percent in the first quarter of 2008.
From the first quarter of 2008 to the second quarter of 2009, personal saving from 1.0 percent to 4.6 percent of personal income. Over the same period, personal current taxes fell from 12.6 percent to 9.0 percent of personal income, so that personal consumption expenditures remained a nearly constant share of personal income.
As the economy recovers, personal current taxes’ share of personal income will naturally expand. This will reinforce the restraining effect of rising saving rates on retail sales and sales tax revenue.