U.S. economy posts solid growth in first quarter, but spending cuts, tax hikes loom

04/27/2013 7:09 AM

04/27/2013 7:15 AM

Americans shrugged off higher taxes to lift the U.S. economy at the start of the year. Government spending fell, though, and the impact of the tax increases along with federal budget cuts could slow growth later this year.

The Commerce Department said economic growth accelerated to a 2.5 percent annual rate in the January-March quarter. That was up from an anemic 0.4 percent annual growth rate in the October-December quarter.

Consumer spending surged at an annual rate of 3.2 percent – its biggest jump since the end of 2010. Growth was also helped by businesses, which responded to the greater demand by rebuilding their stockpiles. And home construction rose further.

Government spending sank at a 4.1 percent annual rate, led by another deep cut in defense spending. The decline kept last quarter’s increase in economic growth below expectations of a 3 percent rate or more.

Many economists say they think growth as measured by the gross domestic product is slowing in the April-June quarter to an annual rate of just 2 percent. Most foresee growth remaining around that subpar level for the rest of the year.

Sal Guatieri, senior economist at BMO Capital Markets, predicts an annual growth rate of 2 percent for the April-June quarter rebound and a 3 percent rate in the second half of the year.

“The second-half acceleration will be supported by improved household finances, pent-up demand for autos and the on-going recovery in housing,” Guatieri says. “We are seeing significant housing-related consumer purchases in such areas as furniture.”

GDP is the broadest gauge of the economy’s health. It measures the total output of goods and services produced in the United States, from haircuts and hamburgers to airplanes and automobiles.

In a healthy economy, with an unemployment rate between 5 percent and 6 percent, GDP growth of 2.5 percent or 3 percent would be considered solid. But today’s still-struggling economy, with unemployment at 7.6 percent, needs faster growth to generate enough jobs to quickly shrink unemployment.

Since the recession officially ended in June 2009, growth has remained weaker than usual after a severe downturn. In part, that’s because the recession followed the worst financial crisis since Great Depression. The economy expanded just 2.4 percent in 2010, 1.8 percent in 2011 and 2.2 percent in 2012.

This had been expected to be the year when growth would finally reach a more robust 3 percent to 4 percent pace. But across-the-board government spending cuts, which began taking effect March 1, have made that unlikely. The cuts are forcing agencies to furlough workers, reducing spending on public projects and making businesses nervous about investing and hiring.

Unless Congress and the White House reach a deal to reverse them, the government spending cuts will continue through the end of the year and beyond.

Consumers’ take-home pay has also fallen because President Obama and Congress allowed a Social Security tax cut to expire. A person earning $50,000 a year has about $1,000 less to spend this year. A household with two high-paid workers has up to $4,500 less. Consumers’ take-home pay is crucial to the economy because their spending drives roughly 70 percent of growth.

Americans appeared to shrug off the tax increase at the start of the year. They spent more in January and February, powered by a stronger job market.

But hiring slowed sharply in March. And consumers spent less at retail businesses.

Economists expect spending to stay weak in the April-June quarter as consumers adjust to smaller paychecks.

Ben Herzon, an economist at Macroeconomics Advisers, thinks the tax increases could shave roughly 1 percentage point from growth this year. He expects the government spending cuts to reduce growth by about 0.6 percentage point.

The drop in government spending cut growth in the January-March quarter by 0.8 percentage point. Three-fourths of that decline came from defense spending.

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