U.S. consumers increased their spending at a slower pace in December, while their income grew by the largest amount in eight years. Income surged because companies rushed to pay dividends before income taxes increased on high-earners.
The Commerce Department says consumer spending rose 0.2 percent last month, down from a 0.4 percent increase in November.
Income jumped 2.6 percent in December from November. Companies accelerated dividend payments to beat the January rise in income tax rates. It was the biggest gain since December 2004.
Consumer spending, which accounts for about 70 percent of economic activity, is expected to slow this year because Social Security taxes increased, leaving Americans with less take-home pay.
The increase in payroll taxes already hurt consumer confidence this month. And consumers will have less money to spend at a precarious time.
The economy unexpectedly shrank in the October-December quarter at an annual rate of 0.1 percent, the government said Wednesday. The contraction was largely driven by a steep cut in defense spending. Still, the dip was a reminder of the economy's vulnerability as automatic cuts in government spending loom.
Analysts predict income growth slowed sharply in January because most bonuses and dividends were paid out in December and take-home pay shrank
But Paul Dales, senior U.S. economist at Capital Economics, said the economy would begin growing again in the January-March quarter, in part because modest hiring will keep consumers spending. He predicts consumer spending will grow at a lackluster 1 percent rate in the first quarter, down from a 2.2 percent rise in consumer spending in the October-December quarter.
The big rise in income and slower growth in spending pushed the saving rate in December to 6.5 percent of after-tax income. That's up from 4.1 percent in November. It was the highest level for the saving rate since May 2009.
An inflation gauge preferred by the Federal Reserve was flat in December and is up just 1.3 percent over the past 12 months, well below the Fed's 2 percent inflation target.
For all of 2012, income rose 3.5 percent, below the 5.1 percent rise in 2011 and the weakest since 2009, the final year of the Great Recession.
Congress and the White House reached a deal on Jan. 1 to prevent income taxes from rising on all but the wealthiest Americans. But they allowed the temporary reduction in Social Security taxes to expire this year.
The tax increase will leave a person earning $50,000 a year with about $1,000 less in 2013. A household with two high-paid workers will have up to $4,500 less.
Some analysts have estimated that the roughly $120 billion in higher Social Security taxes could subtract up to 0.7 percentage point from growth this year.
And other policy decisions in Washington could slow growth further.
The agreement on the fiscal cliff averted income tax cuts on most consumers. But it only delayed across-the-board government spending cuts for two months. The cuts are set to take effect on March 1 if no agreement is reached to avert them.
The Fed announced Wednesday that it was keeping all its aggressive stimulus programs in place. These include $85 billion a month in bond purchases. The purchases are intended to keep long-term interest rates down to encourage spending, boost growth and reduce still-high unemployment.
The Fed also left its target for short-term rates at a record low and said it would stay there at least until unemployment, now at 7.8 percent, stays above 6.5 percent. Many economists think unemployment remained at 7.8 percent in January. The January jobs report will be released Friday.