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Originally published May 28, 2013 at 9:32 PM | Page modified May 29, 2013 at 12:29 PM

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Economy holds despite tax hikes, spending cuts

In a year when tax increases and spending cuts by the federal government were expected to bleed life out of the economy, the strengthening housing and financial markets are proving to be more powerful than acts of Congress.

The Washington Post

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WASHINGTON — A U.S. economy that was supposed to be barely hanging on is starting to look surprisingly robust.

Housing prices rose faster over the past year than they have in the past seven, according to data out Tuesday. Consumer confidence hit its highest level in five years. The stock market rallied another 0.6 percent as measured by the Standard & Poor’s 500-stock index, leaving it just short of an all-time high reached last week. And the national retail price of gasoline fell for six days straight through Monday and is down 16 cents a gallon since late February.

It adds up to this reality: In a year when tax increases and spending cuts by the federal government were expected to bleed life out of the economy, the strengthening housing and financial markets are proving to be more powerful than acts of Congress.

Americans with higher incomes are wealthier thanks to the stock market’s 16 percent rise in 2013. Middle-income earners, whose assets are disproportionately tied up in their homes, are becoming wealthier thanks to higher housing prices — up 10.2 percent in 20 major cities in the year that ended in March, according to the S & P/Case-Shiller home price index released Tuesday.

And lower- and middle-income consumers have benefited from falling gasoline prices.

Those are probably key factors behind overall economic data that has suggested growth that, while hardly gangbusters, is a bit better than the past few years. Gross domestic product rose at a 2.5 percent rate in the first quarter, a bit better than the average over the past several years, and the nation added an average of 196,000 jobs a month in the first four months of 2013, up from 180,000 in the second half of 2012.

Meanwhile, the direct evidence is scarce that government’s tighter control over spending is damaging growth.

A two-percentage-point increase in payroll taxes that took effect Jan. 1, reducing the take-home pay of all American workers, would be expected to put a big damper on consumer spending. But personal consumption expenditures rose at a 1.2 percent annual rate in the first quarter, a not-too-shabby result.

Lynn Franco, director of economic indicators at The Conference Board, said that budget wars in Congress and the payroll tax increase dampened consumers’ mood over the winter but that Americans seemed to weather Washington’s troubles.

“They were shocked,” she said. “They’ve absorbed it. They’ve processed it.”

The Conference Board’s consumer confidence index rose to 76.2 in May, the highest since February 2008 and up from 68.1 in April.

Similarly, while there are ample reports of impact from the automatic spending cuts known as the sequester — such as government employees and contractors being furloughed or unemployment insurance being reduced — the effects are not really noticeable in the broad economy. For example, March and April employment data show steady job creation and no major change in the trend for government employment, or in categories that include large concentrations of federal contractors, such as professional and business services.

So was the impact of Washington’s austerity oversold? Not necessarily. Growth is holding up well in 2013 but would be even stronger if the federal purse strings were not being tightened, according to economic models used by private forecasters and independent agencies such as the Congressional Budget Office.

“All else being equal, growth in 2013 should be better than 2012, because the head winds holding it back are diminishing,” said Michelle Girard, chief economist at RBS. “The impact of the fiscal drag isn’t things getting worse — it’s the absence of things getting much better.”

It is also evident that economists’ intuition about how people will respond to changes in policy does not always hold up in the real data. For example, a worker whose after-tax paycheck dropped by 2 percent Jan. 1 may not have immediately cut back on spending by that amount, judging by retail sales data. Perhaps workers are phasing in the adjustment over months, or keeping up their spending levels but reducing their rate of saving instead. The same could be said of a federal employee seeing reduced paychecks because of furloughs.

In addition, the full economic brunt of sequestration probably has not hit yet. It started taking effect March 1, but many government agencies and their contractors may have delayed their response in hopes that Congress would reduce or eliminate certain cuts. Now economists see it as more likely to have its full impact later in the year.

And there are more caveats to the spate of good news. For example, the pleasant surprises from housing, the stock market and gasoline prices are driving consumer confidence, but that will not necessarily translate into actual consumer spending.

“Over the longer run, households still need to save more, and that’s going to be a restraint on growth,” said Gus Faucher, a senior economist at PNC Bank.

For the economy to continue growing even as the sequestration and tax increases take their full effect, higher housing prices will need to translate into more home construction, higher stock prices will need to translate into companies making new investments, and consumers’ higher level of confidence will need to translate into spending more money.

Until those things happen, there will not be the kind of full-throated economic boom that, four years since the Great Recession ended, the United States is still desperately waiting for.

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