Private consumption is one of the most important indicators of how an economy, and its people, is doing. Steady growth in private consumption at rates of three percent or more tells us that the economy is in good shape. Households experience a growth in standard of living and we should expect lots of new jobs to be created.
By contrast, when private consumption slows to a crawl, or declines, it means that households are in a squeeze. They are experiencing stagnant incomes, or they have heard that unemployment is on the rise and they worry that they may be next. As a precaution they cut down on spending today, put money in the bank and hope to be prepared for tomorrow.
The composition of private consumption can also tell us a great deal about the prosperity of an economy. If on average households concentrate their consumption expenditures to necessities such as food, housing, clothes, utilities and transportation, then the economy overall is not doing very well. On the other hand, the more of their money people put on items that make life comfortable, even luxurious, the better off people are in general.
Thanks to a large database published by the Bureau of Economic Analysis (BEA), we can study private consumption at the state level. This helps us greatly in understanding what economic policies are good for people in general, and what policies are negative for the standard of living.
In a series of three articles I will explain private consumption, analyze the BEA data and put it in the context of economic policy at the state level. Today’s article looks at private consumption in relation to our income after tax, a.k.a., disposable income (Click to tweet). Our decisions to spend or save our money are based in good part on our disposable income, which makes the relation between after-tax income and private consumption a good place to start.
Over time, on average, Americans spend 91.5 cents of every dollar of disposable income. This share fluctuates with the business cycle: it falls to 89-90 cents in recessions and tops out at approximately 93 cents. This may not sound like very dramatic fluctuations over time, but the numbers involved are quite large. In 2014,
This amounts to 91.9 percent of disposable income. If that share had been 93 percent, it would have meant another $142 billion going toward food, clothes, home improvement, new cars, holiday travel, new cell phones, college tuition, cash-paid doctor’s visits...
In other words: consumption is very important to our national economy.
It is also very important to our state economies. Interestingly, spending out of disposable income varies quite a bit between the states. Measured per capita, in some states consumers spend less than 90 percent of their available income; in fact, in Connecticut, Texas, Oklahoma and Wyoming consumers dispose of less than 85 cents of every dollar they have after taxes. By contrast, in 19 states consumers spend more than 95 cents of their disposable income.
Why these differences? The basic economic explanation is that states with a low average consumption rate are states with prosperous residents who can afford to save quite a bit of their money. This could explain why people in Connecticut only spend 84.6 percent of their post-tax income.
Neither Texas nor Wyoming have an income tax, leaving consumers with a little bit more of a margin before they have to start spending. That said, other states without an income tax have higher consumption rates, telling us that we need to dig more deeply into the consumption numbers in order to understand state differences. We will do so in a later article.
Curiously, in seven states consumers spend more than 100 percent of their disposable incomes: Maine (112.7 percent), Montana (108.5), Vermont (107.6), Oregon (102.3), Delaware (101.1), New Mexico (100.6) and Michigan (100.2). On the face of it, these numbers are irrational - on average, consumers cannot spend more than they earn without going bankrupt.
The explanation is in the method used to measure economic activity. The BEA tallies up private consumption per state, in other words how much money was spent as consumption in that state. The method does not take into account who spent it: if a Pennsylvanian drives across the state line to Delaware to fill up his car and buy a lower-taxed pack of cigarettes, then that counts as consumption in Delaware, not in Pennsylvania.
To conclude this introduction to private consumption and the economies of our states, please consider Table 1. It reports per-capita disposable income and per-capita private consumption in the 50 states plus the District of Columbia:
Sven R. Larson is an economist and Member of the Council of Scholars with Compact for America. He has a blog called America’s Fiscal Future and he recently published "Robbing the Millennials: How We Looted Our Kids' Future and the New Handshake We Owe Them"