Tax increases contribute to biggest drop in personal income in 20 years

January 2013 saw the biggest drop in monthly income in 20 years, according to a report (PDF) released today by the Commerce Department. Personal income decreased 3.6 percent or $505.5 billion after a 2.6 percent spike in December 2012. What accounts for the biggest decline we've seen since 1993?

According to CNN, there are two factors that played a crucial role in the drop in personal income.

In December, monthly income was unusually high because companies paid out their dividends early. This was done to avoid the upcoming tax hikes in January 2013. That was a smart move for those making more than $400,000 ($450,000 for couples). In January, the dividend tax rates for that income bracket rose 15-20 percent.

The expiration of the payroll tax cut is the other key factor. Starting in January, most workers had to pay an additional 2 percent to taxes. For someone with an income of $5,000 per month, that's a decrease of $100 monthly. Disregarding these unique circumstances, the Commerce Department estimates that income after taxes actually rose 0.3 percent.

Despite the big drop in personal income, Americans have yet to curb their spending habits. Spending increased 0.2 percent in January, contributing an additional $18.2 billion to the economy. Still, Walmart reports its sales have slowed during the past two months due to delays in income tax refunds, an increase in payroll taxes and higher gas prices.

Spending accounts for nearly two thirds of the U.S. economy; experts predict it will take a hit in the coming months due to the payroll tax increase. It usually takes a couple of months for consumers to adjust their spending habits after their income decreases.

Savings are down, too. In January, people, on average, saved about 2.4 percent of their disposable income, down from 6.4 percent saved in December 2012. This is the lowest monthly savings rate in more than five years.

Have you seen a significant reduction in your income since the beginning of the year? How do you plan to adapt to the changes? Let us know in the comments!

Image courtesy of user Alvimann via morgueFile.