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Know Your Numbers: Personal Income and Spending

As previous articles in this long series on economic data have shown, there are dozens of ways in which various government agencies and business-related organizations track the health of the U.S. economy. Whether you're interested in big-picture macroeconomic numbers like the gross domestic product or specialized information on sales of existing homes, there are a number of measures you can use to find answers to your questions and to learn more about your specific industry and the economy as a whole.

Just as it takes two to tango, it takes at least two parties to engage in an economic transaction. Therefore, in evaluating data about the economy, it's helpful to have information about the parties on both sides of a given exchange. In general, it's fairly easy to gather information from the businesses that generally sell goods and services; simply by looking at a few big companies like Wal-Mart (NYSE: WMT  ) , Costco Wholesale (Nasdaq: COST  ) , and Sears (Nasdaq: SHLD  ) , you can capture transactions involving a large percentage of consumers nationwide. On the other hand, directly gathering information about the nearly 300 million potential individual consumers who populate our country is a larger challenge. Yet to understand economic behavior, you need to understand how consumers behave.

The Bureau of Economic Analysis provides information on consumer behavior in its monthly reports on personal income and spending. This month, personal incomes rose 0.3%, spending rose 0.1%, and the savings rate improved marginally to -0.5%. This information not only teaches valuable lessons about the economic state of American consumers, but also serves to verify data collected from businesses and other sources on the types of purchases consumers make. This article delves into the methodology the BEA uses to collect this information and provides analysis of how to interpret the numbers.

The basic concept
Information on aggregate personal income and spending reveals a great deal about the economic behavior of average Americans. If personal income is rising, then people have more money to spend on necessities and luxuries. Personal spending confirms whether people are immediately using their money or saving it for purchases in the future. Taken as a whole, the two sets of data give an idea of whether consumers are living within their means.

In order to calculate personal income, the BEA obtains information on wages and other income from labor, contributions by employers to pension and insurance funds, rental income from real and personal property, business income from self-employed proprietors, interest and dividends from investments, and transfer payments like Social Security. These figures are added together, and contributions to government transfer programs, such as FICA-related Social Security and Medicare withholding from paychecks, are then subtracted to determine the final personal income number. To calculate disposable personal income, the BEA subtracts personal taxes from the sum.

Personal spending numbers are determined in a similarly straightforward manner. The BEA gathers data on personal consumption of durable and nondurable goods as well as expenditures on services. Also included are interest payments by individuals for debt incurred for personal consumption items, as well as personal transfers made to individuals outside the United States.

By subtracting personal spending from personal income, the BEA determines the net amount of personal savings and can calculate a personal savings rate as a percentage of overall income. This measure is currently negative, a fact that worries many economists, since it may indicate that consumers are becoming overextended in their spending habits.

Criticisms of personal income, spending, and savings
Many people looking at information on personal income and spending, and especially at the net level of personal savings, wonder how the U.S. economy can be doing so well. In trying to answer this question, some analysts have looked at the definition of income used by the BEA and have suggested that it is incomplete. Most notably, although personal income includes dividend and interest income from investments, it does not include capital gains received upon the sale of investments. Given the levels of price appreciation in many categories of investments over the past 15 years, some argue that the failure to include capital gains in the income and savings calculations leads to false characterizations of personal economic behavior as irresponsible and unsustainable.

The BEA website gives three reasons why capital gains are excluded from personal income. First, it argues that capital gains are less available; one has to sell the asset in order to realize the capital gain. Second, it notes that while most other income measures are relatively stable, capital gains are subject to wide fluctuations. Last, the BEA states that realizing capital gains does not result in any net new investment or savings; instead, it transfers capital from one investment to another, with a neutral effect on the overall amount of capital in the economy.

Although the BEA's responses are understandable, investing has changed in recent decades to bring some of its ideas into question. While nearly all companies traditionally paid dividends to shareholders, it is now fairly common for companies to pay minimal or no dividends, especially in certain capital-intensive industries like telecommunications. For many years, technology stalwarts like Microsoft (Nasdaq: MSFT  ) and Intel (Nasdaq: INTC  ) paid no dividends at all, and others, such as Dell (Nasdaq: DELL  ) , still pay no dividends. Yet in their time, these companies created huge amounts of wealth for their investors. Also, while capital gains on some illiquid assets, like real estate, can be difficult to realize quickly, the rise of online brokers like TD Ameritrade (Nasdaq: AMTD  ) and E*Trade (NYSE: ET  ) have made it simple for investors to liquidate stocks with the click of a mouse.

Conclusions
Although personal income and spending data reveal aspects of consumer behavior, the indicator is an example of how certain information confounds strong conclusions even over long periods of time. The savings rate's decline in recent years, in combination with other data like the current account deficit, have some convinced that a major economic depression is imminent. Yet many of these factors have been in place for a long time, making the pronouncements of these critics sound like children crying wolf. Whether the wolf will eventually arrive, however, remains to be seen.

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Get helpful hints for increasing your income while reining in your spending by subscribing to Motley Fool GreenLight. This new newsletter promises practical advice that leads to more money in your pocket. Check it out today with a free 30-day trial.

Fool contributorDan Caplingerbelieves keeping personal income above personal spending is the key to personal happiness. He doesn't hold positions in any of the companies mentioned in this article. Dell, Intel, and Microsoft are Motley Fool Inside Value picks; Dell and Costco are Stock Advisor picks. The Fool'sdisclosure policykeeps you informed.


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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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