The Economy

The explosive growth in retail sales is off the charts. During the last six months, retail sales have grown 6.3%, reflecting an annual rate of 13%. Even though economic and financial conditions have been favorable, none of the economic data supports that large a gain. It's true that the S&P 500 has rebounded from its October lows, but by the same token, interest rates have also risen from those lows. Real disposable income continues to rise between 3% to 4%, a rate that has hardly changed during the last four years. Since there are some lags built into the system, consumers may still be reacting to the previous rise in stock prices and drop in interest rates, but that would not explain the jump in retail sales from a 5.1% annual rate of gain during the first three quarters of 1998 to the most recent 13% gain. Something else must be at work. One possibility is that consumers are already spending their next tax cut. One could claim that consumers aren't the only ones who don't know when the next tax cut will occur; Congress and the President don't know either. In fact, only 22% of those recently polled said they were in favor of a tax cut. Nonetheless, as the surplus swells above $150 billion later this year, it seems likely that Congress will push to provide the voters with a tax cut in an election year. In this regard, it may be worth checking how consumers reacted to the Reagan tax cut. This cut was phased in over three years, with the reductions occurring in 1981.4, 1982.3, and 1983.3. The first phase had virtually no impact because it was only a 5% rate cut, and was largely offset by higher Social Security taxes and the "inflation tax" that pushed people into higher brackets. Thus, consumers essentially received a two-stage tax cut consisting of a 10% reduction in rates in mid-1982 and another 10% reduction in mid-1983. The personal saving rate fell from 9.8% in 1982.2 to 6.4% in 1983.2, before the second phase of the tax cut; after that, the saving rate rose to a peak of 9.3% in 1984.3 before declining again. Essentially consumers spent the latter half of their tax cut before they got the money. If the recent stunning drop in the saving rate and rise in retail sales can be explained by other factors, the expectation of a future tax cut plays only a trivial role. On the other hand, if the recent behavior of consumers cannot be explained by the usual variables, the expectation of a future tax cut is probably one of the factors fueling the recent spending boom. The personal saving rate fell to an estimated -0.6% last quarter, which means it declined one percentage point during the last year. Over the long run, a one-point change in both stock prices and mortgage rates has affected the saving rate by about 0.03 of a point. For example, if the stock market rose 20 points more than its average gain, that would reduce the saving rate by 0.6 of a point. Since the long-term average gain in the stock market is 8%, the recent gain of slightly more than 18% probably reduced the saving rate by 0.3 of a point. Interest rates were virtually unchanged, and the stronger growth in income usually boosts the saving rate, ceteris paribus. So the recent drop in the saving rate cannot be explained by these "traditional" variables. Another possibility is that the misery index, which equals the unemployment rate plus the inflation rate, has declined to a 35-year low. Yet in the early 1960s, when the misery index was at similarly low levels, the personal saving rate averaged about 7.5%, not -0.6%. I may have missed some other variables that have boosted retail sales growth to record levels and reduced the saving rate to record lows. Nonetheless, when history is written, I think the anticipation of the forthcoming tax cut will turn out to be one of the major factors that helped fuel the recent boom in consumer spending. Michael K. Evans is president of the Evans Group and professor of economics at the Kellogg School of Business, Northwestern University, Evanston, Ill. His e-mail address is [email protected].