Why Many Americans Feel Like They're Getting Poorer Data released by the Commerce Department last week showed that personal income fell 3.6% in January, the biggest decline in 20 years. The drop was even bigger when taxes and inflation are taken into account. Real personal disposable income fell by 4%, the biggest monthly drop in half a century. In part, this is a statistical blip. Companies accelerated certain payments - giving year-end bonuses in December rather than January, for example - so that employees could avoid higher taxes going into effect for 2013. But even if that blip is smoothed out, real aftertax income is lower than it was six months ago. What this means is that the U.S. economy is not merely recovering from the recession more slowly than one might like, but is actually getting worse for many Americans. Despite three-and-a-half years of uninterrupted growth in real GDP and a decline of more than two percentage points in the unemployment rate since 2009, the standard of living is falling for as much as half the population, particularly if you look beyond monthly numbers to longer-term trends. Commentators assessing a recovery in progress naturally tend to focus on changes from one month or quarter to another. But what really matters is not how the economy compares with where it was in earlier time periods, but how it compares with where it would now be if it were fully utilizing all of its resources. Economists call this level "full capacity," and it rises over time as the population grows, technology improves and facilities are upgraded. When a recession occurs, the economy's actual output drops significantly below the full capacity level, creating what's known as an "output gap." Once the recession ends and a recovery begins, there's normally a period of well-above average growth so that actual output regains the ground lost during the recession and comes back close to full capacity. But since the most recent recession ended, growth has never been fast enough to close the output gap - indeed, the gap has hardly narrowed at all. One unfortunate consequence is that worker productivity has stalled. Productivity typically soars after a recession because many businesses have unused capacity and can handle somewhat higher sales before they have to start hiring or investing in new facilities. A travel agency, for example, could book a few more vacations before they have to hire another travel agent or move to larger offices. Following the most recent recession, productivity growth did soar, briefly reaching an annual rate of 8%. But because the output gap hasn't closed since then, productivity has barely improved since 2011. The lack of robust productivity gains has allowed wages to remain stagnant. There is enough growth for companies to enjoy rising profits, but not enough to make it worthwhile for them to hire more and pay more. In a normal recovery, sales gains are normally split between profits and labor compensation. But in the current recovery, profit growth has outpaced sales, while labor compensation has actually lost ground. Taxes also affect the amount that people take home. With GDP in the past quarter barely keeping up with inflation and productivity gains averaging around 1% a year, you'd expect middle-class incomes to show less than 2% real annual growth. So the expiration of the payroll tax cut - which effectively raised taxes by two percentage points on incomes up to $113,700 a year - is by itself enough to depress real disposable incomes for many American households. And other taxes and social charges have risen as well. What's clear in all this is that a true recovery requires closing the output gap and restoring income growth for middle-class households. That can't be done with short-term budget cuts that cause layoffs and reduce GDP growth further. And it can't be done with tax increases, which also discourage growth and can hit less-affluent households hard even if they are aimed at the rich. It's true that the U.S. is accumulating a disturbingly large amount of debt. But the cause is mostly the soaring cost of Social Security, Medicare, and other entitlements. And it will be some years before that debt load becomes truly dangerous. The conventional wisdom is that the economy will suffer seriously when publicly held U.S. debt (not including the Social Security Trust Fund) reaches 90% of annual GDP. The Congressional Budget Office projects that debt will not reach that level for more than a decade. Government policy seems backwards, in fact, whichever party's views end up prevailing. What's needed instead is a pro-growth agenda that will close the output gap. It's certainly reasonable to trim discretionary spending where it is wasteful and to make tax law fairer. But what's far more important over the long term is to slow entitlement growth without reducing current benefits. In addition, broad tax reform that closes loopholes so that marginal tax rates can be reduced would be helpful. And regulation needs to be streamlined where it creates unnecessary burdens for investment and job creation. There's little point in policies that will keep the U.S. economy mired in its current stagnation. And it would be nice to address the long-term problems before a crisis forces drastic action.