We looked at a paradox yesterday: While unemployment rose, average working hours fell, incomes stagnated, savings increased, and debt was repaid, Americans kept their wallets open and spent a decent amount of money. Those don't add up. What gives?
These are complicated topics where no single answer tells the whole story. You can probably think of a dozen explanations for the paradox. But to me, this one is the most fascinating:
Source: Federal Reserve, author's calculation.
Some background here. Transfer payments are income people receive from state, local, and federal governments -- things like Social Security checks, unemployment benefits, food stamps, welfare, and so on.
This chart is simple. It's the percentage difference between what people bring home, and what they bring home minus government transfer payments. The higher the line is, the more we're reliant on the government, and vice versa.
And it's pretty clear: We've been more reliant on transfer payments over the past four years than ever before. That helps explain why Americans found enough money to keep spending while income from work declined; Uncle Sam made up a lot of the difference.
These aren't small numbers, either. In 2004, the difference between real income and real income without transfer payments was 16.5%, or $1.4 trillion. Today it's 21.5%, or more than $2 trillion. That difference -- $600 billion a year -- works out to around $2,000 per American, per year. From 2000 to 2009, the amount governments spent on benefit programs increased 69% after inflation.
According to an in-depth report by New York Times reporter Binyamin Appelbaum, nearly half of Americans lived in a household that received direct government benefits in 2010. That's up from 37.7% in 1998. Another example of the growing safety net:
When the earned-income credit was introduced in 1975, eligibility was limited to households making the current equivalent of up to $26,997. In 2010, it was available to families making up to $49,317. The maximum payout, meanwhile, quadrupled on an inflation-adjusted basis.
As unemployment rose during the recession, spending on unemployment benefits increased as well. According to Federal Reserve data, around $30 billion was spent on unemployment insurance in 2007, before the recession began. It shot up to $145 billion in 2010, and still runs close to $100 billion a year today.
Part of the rise in transfer payments is due to simple demographics. As the baby boom generation ages, those eligible for Social Security and Medicare rises. Fifty-six million Americans now receive Social Security benefits. That's 10 million more than did in 2002. Between 2000 and 2020, the number of Americans age 55-64 will have grown 73%. Most will be eligible (or very soon be eligible) for Social Security and Medicare.
Virtually none of these increases were financed through higher current taxes on more productive workers. Adjusted for inflation, federal tax revenue in 2011 was 9.8% lower than it was a decade before. Taxes as a percentage of GDP hit the lowest level in the last half-century in 2010, and average effective tax rates are near the lowest they've been since the IRS began keeping track.
Those are the numbers, and they help explain why consumer spending held up while the wages generated from jobs did not. What should you make of them? I'd keep two things in mind.
One, being reliant on transfer payments means the economy is susceptible to decline when it comes to austerity. There's a fierce debate right now over when and how to curb the budget deficit. Someday, somehow, the deficit will need to shrink dramatically -- that much is clear. But too often lost in the debate is that what one person views as wasteful spending is another person's income, and that income can be key to supporting the economy, especially in the wake of a deep recession. Austerity and deficit-reduction don't occur in a vacuum. Europe is learning this the hard way right now.
A second related point: The fact that such a massive amount of government money is spent on transfer payments shows why deficit reduction is so difficult in the first place. News flash: most people like getting checks in the mail, and they're loath to give them up. There's disagreement over deficits and debt, but the majority of government spending is on programs that are popular and defended by both major political ideologies. And the more reliant we are on transfer payments, the harder it is to wean off of them. "Even critics of safety net increasingly depend on it," Appelbaum wrote.
He then asked a small-business owner and self-described opponent of government largess named Ki if he could imagine retiring without Social Security or Medicare. "I don't think so," Ki said. "No. I don't know. Not the way we expect to live as Americans." And there's the problem.
Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.