U.S. businesses slashed spending on machinery and equipment in January after a tax break ended, plummeting orders to the lowest level in the past 3 years.

The Department of Commerce said on Tuesday that orders for durable goods – items such as airplanes, computers and household appliances —fell 4 percent last month to $206.1 billion.

The decline followed increased demand in the past three months, including a 3.2 percent rise in December. Economists surveyed by Bloomberg only expected a 1 percent drop in January.

The durable goods report is considered to be volatile—orders tend to decline in the first month of a quarter only to pick up later. Nonetheless, economists called the drop “surprising” and “disappointing.”

Demand fell in most categories. The biggest decline came in computers and machinery falling 10.4 percent to $30.6 million. Non-defense aircraft orders fell 19 percent.

Most alarming, however, was the 4.5 percent drop in non-defense capital goods excluding aircraft.  This is a regarded as a good measure of business investment plans and the latest figure suggests concerns about the future of the economic recovery in the private sector.

“That surely raises some flags about the strength of businesses,” said Michael Feroli, Chief US Economist at JP Morgan.

Much of the decline in January is attributed to the 2011 tax credit also known as the bonus depreciation incentive– which allowed companies to write off 100 percent of new purchases up until the end of last year. Since January 1st, firms are allowed a 50 percent write off — an issue that remains caught up in debates between the Republicans and the Obama Administration.

“The expiration of the tax credit prompted a slowdown,” said John Herrmann, President of Herrmann Forecasting in New Jersey.

Indeed it has.

The tax incentive spurred businesses to pull core capital goods orders forward to the second half of 2011 — creating an all time high in December as most companies boosted output reaching the best growth since the beginning of the recession in 2007.

Yet, economists said that might not be the only reason causing the decline in January.

While the American manufacturing sector has been holding a prominent spot in the global economy, the on-going European instability could have been a reason on the January orders weakness.

“There has been a notable weakness in business equipment, primary metals and electrical equipment – goods we usually ship overseas,” said Scott Anderson, Senior Economist at Wells Fargo Securities. “This could be a result of a European effect.”

In addition, many have pointed to yesterday’s Institute for Supply Management report –which measures national manufacturing growth, employment and deliveries based on surveys – as an indicator that the economy is not recovering above its capacity.

“ISM orders in February showed that manufacturing as a whole was weaker than expected. This is consistent with durable goods and we can consider that to be cautionary sign for the future of the economy,” said Anderson.

Nonetheless, economists usually refer to the month of January as what they call a “soft start” in the economic cycle. Hence, even with a disappointing start of the year, their outlook remains optimistic. Economists predict a steady single digit growth in the coming months.

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