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Today’s personal income and spending update for January looks like a warning of things to come, but not for the obvious reasons. The weasel in the henhouse is all the more troubling at the moment since it’s masked by the all-important topic of consumer spending, which rose substantially last month. Beneath this rosy surface, however, is a potentially troubling trend.

But first the good news, such as it is. Personal consumption expenditures rose a strong 0.5% last month, the best pace since October. That’s above average by the standard of the past decade. Worries that Joe Sixpack is set to close up shop and save, save, save are on hold again, or so the latest government numbers suggest. But there's a slight glitch. As our first chart below shows, consumer spending rose last month (red line), but the jump coincides with a rather sharp fall in disposable personal income (black line). What’s going on here? (Click charts to enlarge)

The drop in income reflected an increase in various tax deductions. Indeed, wages overall were up last month, but the BEA reports that a relatively larger bite in domestic “contributions for government social insurance” and “current personal taxes” turned a gain into a retreat for monthly disposable personal income. By recent standards, the rise in taxes looks unthreatening, in both absolute and relative terms. But recent standards are almost certainly misleading, thanks to fiscal stimulus of late and the government's recession-era policy of helping smooth over the rough edges of the Great Recession by putting more money in taxpayer’s pockets.

The outlook for red ink of unprecedented proportions on the government’s balance sheet suggests that Washington will have to dip its hand ever deeper into the taxpayer till in the years ahead. Did the uptick in government deductions last month signal the start of this trend?

Consider two charts that track the last three years of the relative tax bite on personal income. The chart below shows the percentage of personal current taxes relative to personal income on a monthly basis. “Personal current taxes consist of taxes on income, including realized net capital gains, taxes on personal property, payments for motor vehicle licenses, and several miscellaneous taxes, licenses, and fees,” according to the BEA.

The next chart shows the ratio of so-called social insurance deductions to personal income. These taxes fund a number of programs, including Medicare and Social Security, BEA advises.

In both cases, the change in trend is obvious, or so it seems. One month is hardly definitive evidence of a secular shift, but given what we know about government finances, last month's uptick may be more than just statistical noise. Indeed, the trough of December has given way to a rebound in the relative share of tax deductions in January. Given the mounting liabilities facing the government, one doesn't need a wild imagination to expect that the path of least resistance is up for Uncle Sam's relative cut of wages in the year's ahead. Think of it as the new headwind--and one we need like a hole in the head at this point in this business cycle.

For all the troubles of the last two years, one favorable trend has been the general decline in the relative tax burden on wages. All the better since it came when wages overall have tumbled from the lofty peaks of 2007 and early 2008. But for reasons of fiscal integrity, it's getting harder to keep the government's tax burden at the low levels that have prevailed over the last 24 months without cutting spending by more than trivial amounts. And if that isn't enough of a headache, all of this comes at a time of heightened risk that overall economic growth may be substandard for the foreseeable future.

Even if we ignore tax rates, reasonable minds might wonder about the momentum in the broader rebound for spending and income over the past year. As our fourth and final chart below indicates, the annual pace of change in personal income and spending has peaked, at least for the moment. It's unclear what comes next, thanks to a number of rather large unknowns lurking, starting with the labor market.

But we know the key question: What will keep the spending and income recovery alive? The big-picture answer, of course, is economic growth. Will we see any? And how much? The details that deliver an answer are likely to be messy for the year ahead.

Source: Taxes and Personal Spending