Archive for the ‘Fiscal Policy’ category

Great Expectations

June 6, 2017

“Take nothing on its looks; take everything on evidence. There’s no better rule.”        

    Mr. Jaggers to Pip,  in Charles Dickens’ “Great Expectations”

Optimism in the U.S. economy has been high for most of 2017.  Consumer and small business confidence are both higher than they have been in a decade  and according to the Business Roundtable the CEO’s of America’s largest corporations haven’t been this optimistic in eight years.


From survey data alone the U.S. economy appears to be booming.  But the hard, quantifiable data (1.2 percent GDP growth in the first quarter of 2017) tells a story of more tepid growth.  The degree of divergence between soft (survey and sentiment data) and hard economic data is striking and either consumer and business sentiment will lead to higher rates of growth or sentiment will begin to wane – something has to give and my money is on the latter.

The divergence between sentiment and actual economic performance can be especially problematic for lawmakers crafting state budgets.  With so much economic optimism it is easy for those urging caution in budgeting (based on expected revenue) to be the skunks at the garden party. I don’t know who has the best revenue estimates on which to base NH’s next budget but the trends I see (and present later in this post) urge caution in assuming current levels of consumer and business optimism will be matched by revenue growth.

Still, the economic recovery remains on track (albeit at a modest pace by historical standards) and it has a better than 50/50 chance of becoming the longest expansion in U.S. history by lasting into the middle of 2019.

Length of recovery

The current expansion is getting old but expansions don’t die of old age; something kills them (think the savings and loan crisis in the 1980s, the dot com bubble in the early 2000s, and the mortgage and financial crisis of the recent recession).  Right now, the economy does not seem to be harboring the kinds of excesses and imbalances or overindulgence that have presaged sharp slowdowns or recessions in the past. There are some areas of concern; at more than 20 times earnings, stock market valuations (depending on which index is used) are well above the 15-17 time earnings that is the historical average, but this is not at the “irrational exuberance” stage.  Economists tend to write-off or disbelieve negative economic data as statistical anomalies or due to temporary factors prior to slowdowns and lately a bit more of that has been occurring than I am comfortable with.  But even as there are some unflattering economic indicators that should be acknowledged they are still too new to be trends.  No one is saying the “r-word” and the best we can say today is that we are one day closer to the next recession.

There is no more important task for policymakers than estimating revenues. Underestimating state government revenues results in more needs being unmet than is desirable, while overestimating revenues can lead to difficult and painful spending cuts in later years. So why should NH lawmakers be cautious in their revenue estimates in a time of optimism and apparent abundance?   As Dickens (Mr. Jaggers) would say “take nothing on its looks; take everything on evidence.”   In the case of state government revenue the “looks” are reports of a booming economy and high confidence while the “evidence” is real trends in revenue growth.   Analysis and empirical evidence are not currently in favor as tools for governing, at least at the national level, but the great majority of lawmakers in NH value data and evidence and do their best to employ rigor in the budgeting process.  But a focus on monthly revenue reports and numbers can sometimes make it difficult to separate the signal from the noise in the revenue trends. In addition, while it is important to note how actual revenues compare to “planned” revenues on a monthly basis, revenues can meet “planned” expectations at the same time they are signaling a weakening trend.  Thus it is possible that lawmakers can be optimistic that revenues meet or exceed expectations in any month at the same time revenue growth is slowing.  Which is the more important trend?  When I look at the larger trends in state revenue collections from NH’s nine largest sources of own source, general revenue, I see a slowing growth trend even as revenues have generally met monthly expectations.  The chart below shows the year-over-year percentage change in annualized (sum of prior 12 months) state revenue collections.

Annualized NH revenues

Examining NH business tax collections reveals a similar trend of a declining rate of growth.   The chart below shows the rate of change in annualized (sum of the prior 12 months) business tax collections, along with the trend in rate-adjusted revenue to control for the impacts of rate changes on growth rates.

Annualiz NH Business Taxes

The growth rate of meals and rental tax collections in NH (more commonly called meals and rooms) has also slowed.  The chart below shows annualized growth in spending on meals and rooms in NH.  Because the data shows spending on meals and rooms rather than tax collections the data is free from any changes related to tax rates.

Meals and rooms trend

Many factors influence rooms and meals and hospitality expenditures in the short-term (weather, gasoline prices, etc.) but the most fundamental factor that determines longer-term (longer than month-to-month) trends in meals and rooms expenditures are employment and earnings trends in the state and New England region.  Employment continues to grow but at a somewhat slower rate as the nation and the region confront full-employment and labor shortages. Wage growth is occurring but prices are also rising and as the figure below shows, real (inflation adjusted) earnings growth has been trending downward in the U.S. and New England (the same is true for NH).  The result is that the rate of growth of consumer expenditures, in almost all expenditure categories, has slowed.  The chart below presents an estimate of trends in the growth of real earnings (employment times the average hourly wage times average number of hours worked and adjusted for inflation) in the U.S. and New England.  The earnings of New England residents and their ability and willingness to spend have a significant impact on several NH revenues.

Real Earnings Growth

The relationship between spending on meals and rooms in NH and real earnings in New England (lagged) is evidenced in the graph below.

M&R and NE Earnings

I don’t know who is more accurate in estimating revenues in the current debate over the state’s next budget.  There is a case to be made for different expectations.  As long as policy decisions are made based on some empirical interpretation of trends in the economy and revenues rather than an ideological push for more or less spending I think the state will be fine regardless of what lawmakers decide.  I am frequently in error but rarely in doubt and I’ve presented one of what are many interpretations of revenue trends in NH.  Despite what I see as a lot of unmet needs in the Granite State, the trends highlighted in this post urge caution in pillorying anyone who argues for fiscal restraint at a time of so much economic optimism.

“Honest Brokers” and Revenue Estimates

May 14, 2013

Unlike the federal government, states can’t easily budget and spend more money than they take in revenue so revenue estimates play a much more important role in state budgeting than they do  in federal budgeting.  I don’t know how anyone can accurately forecast revenues when the revenue yields are based on negotiations, lawsuits or other non-economic variables but that seems to be the basis  of much of the disagreement among budget writers in New Hampshire. When a comparatively large percentage (compared to many other states) of your revenues are derived from a “Medicaid enhancement tax”  and “tobacco settlement”  money budget writing can become even more politicized than usual.

I don’t pretend to know what these non-traditional sources of revenue will yield in the coming years but I get a sense that those who do are fitting their forecasts to their meet their budgetary goals.  I  don’t think revenue forecasting is that difficult as long it is based on real economic data and trends and it minimizes the use of assumptions about changes in the performance of the economy.   I make forecasts with assumptions all the time but  minimizing their use  in revenue forecasts will mean that even if the forecast is wrong, it won’t appear as though the error resulted from a desire to “coax” a specific result from the forecast.   In January I presented my outlook to the NH House Committee on Ways Means.  At that time I said I thought revenue growth from major, “own-source” revenues would average about 2% each year of the biennium and that businesses tax revenue growth would be a bit higher, but with even modest economic improvement could average 5-6% annual growth.  Now, several months later, based on recent revenue performance, and making  no assumptions about significant changes in economic conditions, I see growth at about 3% in FY 2014 from the eight largest sources of general revenue, and just under 5% in 2015.  Those numbers don’t count the “non-traditional” revenue sources but I think they are important in reflecting the fundamental underlying growth in the state’s economy and a better assessment of  general revenue trends.

NH General revenue forecast

Clearing out some old boxes from my attic  I came across a number of old college tests and papers.  One was from a graduate school class on public finance where I argued that all federal budgeting and budgeting  debates should proceed from a common economic and revenue forecast.  I also found one from an undergraduate class on the philosophy of Marxism in which I wrote phrases like “man should never be a means to end but only an end in himself ” so clearly I was prone to a lot of bad and muddled thinking back then.  In the 1990’s I wrote a column in a publication arguing for a non-partisan revenue estimating committee in NH.  That was a pretty good idea  and it did happen – although my prompt had nothing to do with it –  and it was enacted largely absent the “non-partisan” aspect (or at least “unbiased”).  I still think a true, non-partisan, representative revenue estimating panel would be a good thing for NH, not to bind any actions but simply to serve as a baseline scenario that any policymakers who wishes to deviate from would have to offer solid reasons for doing so.  Some group in the budget debate has to serve as the “honest broker”  but the honest broker role won’t happen if the group is loved too much by some or hated too passionately by others.   The current estimating panel has some of the best and most qualified people I know to do revenue estimating .  It just doesn’t have the  credibility among many policymakers that it could have  if  no one loved or hated it too much, but instead almost everyone complained a little (or a lot) about  it.  It is too bad because we are still going to need an “honest broker” when the NH House and Senate begin negotiations on the next budget.

The Shrinking U.S. Deficit

May 1, 2013

Annual budget deficits since 2009 have been the largest in a generation. The deficit-to-GDP ratio, which averaged 2.5% from 1980 to 2007, peaked at 10.1% in 2009 as the recession reduced tax revenue and spending rose with the economic stimulus package.   There is still a long way to go but the deficit to GDP ratio has improved each year since 2009 and will likely continue to do so for the next few years. The chart below shows a reasonable proxy of the official federal deficit – it shows the 12-month moving average of the difference between federal revenues and federal spending.  Over the past year this deficit estimate has improved by an average of $28-$30 billion per month, much better than the CBO’s 2013 deficit projections.

Monthly U.S. Deficit Proxu
The deficit is shrinking because of a combination of higher revenues and slower spending. To this point deficit reduction has largely been the result of higher tax revenue resulting from an improving economy, the expiration of the payroll tax holiday (worth about $135 billion this year), and higher tax rates for upper income individuals but spending reductions are beginning to play a larger role.

Lower deficits and a reduction in the national debt as a percentage of GDP will help economic activity in the long run.  Although there are many short-term factors that influence the relationship between federal debt ratios and GDP growth, over the longer-term, higher debt levels are associated with slower GDP growth and lower debt levels are associated with higher GDP growth.

Debt and GDP Growth
The deficit is contracting faster than expected, but the goal of deficit reduction can have negative implications from either excessive taxation or spending cuts that significantly impact demand. The Federal government accounts for roughly 7% of total economic output and has shrunk by an average of about 10% each of the last two quarters.  So while the good news is that deficit-reduction is likely to be greater than expectations in the near term, the cost from tax increases and spending cuts will likely lower real GDP growth by about 1% over the next year.

Getting What You Want But Not What You Need

April 10, 2013

Business taxes are about one-quarter of NH state government revenues and an even higher percentage when you take out sources such as the statewide property tax which is largely an accounting fiction that really does nothing to support state services.  That is a higher percentage than any state with the exception of some states that get oil, gas and mineral extraction revenues.

When business taxes are that important to a state’s fiscal health it better make sure that it takes care of its businesses and its business climate because if and when they go south (or south and west just as more people have) it becomes very difficult for the state to produce a budget.   The chart below shows how NH’s “own source” general and education fund revenue from the nine largest sources of revenue (exclusive of the statewide property tax) have grown comparatively since 2003.  I think the chart shows how important trends in business tax revenues are to overall revenue trends in the state.  The bad news is that revenues from the business profits and business enterprise tax are still more than 20 percent below peak.  The good news is that they are growing.

Growth in Own Source Revenue

The chart also says a few other things to me.  First, a strong and dynamic business climate is the best fiscal policy for the state.  Second, if you are going to cut business taxes you had better be certain that it is a good way produce a strong and dynamic economy because if not, the fiscal health of the state will suffer.  Third (and related), if revenues rise in response to cuts in business taxes great, it will be evidence of a stronger economy and healthier state finances, but if revenues  fall you better be sure that the service and spending reductions that result don’t affect those things that most contribute to a strong and dynamic economy because economic growth (and thus revenues) will be at risk for falling further.   All businesses want lower taxes and it that is the quickest and easiest way for policymakers to demonstrate how much they love  businesses.  But businesses also need and want a lot of other things to prosper and, like lowering taxes, they aren’t shy about asking for them.  Unfortunately, in a state so dependent on business tax revenues businesses getting what they want can sometimes make it more difficult to get what they need.

NH lawmakers, like lawmakers in most other states, want prosperity and opportunity for residents .  Most  also recognize that a strong and dynamic economy is the way to assure that.   So unless you are big financial institution, a big oil company, or just about any business or industry that is prefaced by “big,”  it’s a pretty good time to be in business because almost everyone wants to show you some love, they just can’t agree on how to demonstrate it.  Right now a lot of ideology and little evidence is being brought to bear on the question of “what policies are most helpful in producing a strong and dynamic NH economy.”   That makes it a lot harder to see that we all have a common interest in a strong economy and even more difficult to agree on what to do about it.

What’s Behind the Weak Jobs Report?

April 5, 2013

Bad news arrived today with the release of the monthly employment report by the U.S. Bureau of Labor Statistics.  Only 88,000 non-farm jobs were added across the country in March. Following  two months which saw the U.S. add 148,000 and 268,000 jobs respectively in January and February, the low number raises concerns that the U.S. may again be heading for a “Summer slump” after showing signs of stronger job growth early in the year.

I share that concern but I am most interested in what the job growth numbers may or may not imply about recent U.S. economic and domestic policies.  I know sequestration is the hot policy topic and may be blamed or credited for all evil or good that occurs in the U.S, economy this year, but it is really too early for it to register much  impact on March’s job growth.  Two other policies have the potential to more significantly impact job growth in the near term.  The details of the March employment report provide some clues about if and how these policies may affect job growth in the future. The elimination of the temporary reduction in the payroll tax and health care coverage mandates in the Affordable Care Act are policy impacts that we worried about before we started worrying more about the potential impacts of sequestration.

I last posted that gains in home values, stocks and, retirement accounts along with increases in wages and salaries would help the economy overcome the large potential impact on consumer spending from the rise in the payroll tax (elimination of the temporary rate reduction) that took effect in January.  I may have been a little too optimistic about those factors ability to help the U.S. economy overcome more than $100 billion in lost consumer spending power (over $600 million in New Hampshire).   For me, the most troubling piece of data from the March job growth report was the seasonally adjusted decline of 24 thousand retail trade workers and generally downward trend since January, that has followed several months of solid gains in late 2012 (chart below).

U.S. Retail emplyoyment

When housing values are recovering, homeowner’s equity is rising, and employment and wages are growing, retail employment should not decline.  The elimination of the payroll tax cut (along with higher gasoline prices early in the year) likely provided a greater shock to consumers than anticipated.  But another explanation is that implementation of the health care mandates of the ACA could be affecting employment more in some industries.  If so, it would likely impact industries that typically are less likely to offer their employees health care coverage and industries that employ more part-time workers.  Retail and leisure and hospitality industries  meet those criteria but only retail trade lost employment in March.  Because the ACA mandates coverage for full-time employees, one way to avoid the mandate would be to increase part-time employment.  In that case I would expect the average weekly hours of workers in retail or other industries that may be more  affected by the mandate to decline, as more workers were shifted to part-time status but average hours have increased slightly in retail over the past three months.  Looking more closely at the data on part-time employment is needed to get a handle on any ACA impacts.  Over the next few months I will be looking for evidence of  increases in the number of workers working “part-time for economic reasons” – meaning they are working part-time when they want to be working full-time, as well as employment trends in businesses employing between 50 and 499 workers (those most affected by ACA).  Trends in these employment data would provide stronger evidence of any ACA effects but for now, it looks like the payroll tax is the culprit in the retail employment data.

Funding Roads and Bridges to Perdition

March 25, 2013

Gasoline taxes, road tolls and highway infrastructure spending are issues at the forefront of a lot of heated debates in state legislatures across the country.  I am going to write about the issue a couple of times this week.   Some lawmakers want to raise sales or other taxes to pay for infrastructure and others want to increase gasoline taxes and other “user fees” to pay for it.   The highway infrastructure spending and revenue issue can illustrate classic principles of sound fiscal and economic policy so it is too bad that the debates have generally taken the “low road” by framing the issue almost entirely as either one of “who wants to raise taxes and who doesn’t,” or “who wants to makes roads and bridges safe and who doesn’t”.

User fees are a good thing and it is sound fiscal policy to have the users of roads pay for them via gasoline taxes, road tolls, and other fees that reflect an individual’s usage of roads and bridges.  When general revenues are used to pay for roads and bridges people who don’t necessarily use them wind-up paying for a portion of highways and subsidize the usage of roads of those who travel them a lot.  When you subsidize something you can bet you are going to get more of it than you would have gotten without the subsidy and in this case that means more travel on roads which, of course, means there will be more need for roads and spending on roads and that means more subsidy and that approach is surely a road to perdition.

It was nice to see New Hampshire rank high in a recent report (issue brief) by the Tax Foundation on the percentage of  highway spending that is funded by user fees like gasoline taxes, tolls and other fees.  Unfortunately, in making good points about user fees, the Foundation draws the wrong conclusion about the data it uses to make them.  That happens a lot when you use bivariate analysis to draw conclusions in a multivariate world.  Instead, using multivariate (regression) analysis on the data, it becomes clear that it is less the use of good principles of fiscal policy that results in states paying for a higher percentage of the costs of highways with user fees, than it is a function of the volume of federal government grants they receive.  So a cursory look at the Tax Foundation’s report can give NH a sense of superiority in fiscal policy over many states (while I generally think that is true about NH it is not so much in this case),  and especially over Vermont because that state funds just under 20% of its highway spending with user fees compared to NH’s 42%.  The real reason those percentages are what they are is that Vermont receives about 64% more federal highway funds per capita than does NH ($220 to $134 in 2010). The chart below shows the simple relationship between the percentage of highway spending in a state that is funded by gas taxes and user fees and the amount of federal highway funding per capita in each state.

User fees and Fed funds

States like NH that fund a higher percentage of highway expenditures with user fees do generally receives lower amounts of highway funds from the feds (the data point slope downward to the right).  There are even more intervening variables, like the amount of federal highways (by mile) and as a percentage of all highways that are in a state but still, by far, the amount of federal highway funding per capita is the best predictor of the volume of highway spending per capita in each state. The amount of motor vehicle-related user fees per capita were a distant second but still significantly related to highway spending.

Fed Highway per capita

Almost everyone agrees that NH’s (and every other state’s) roads and bridges are in need but I don’t think the debate is ever going to be about the wisdom of user fees versus general revenues in paying for highway infrastructure.  It is too bad because if it were we just might reduce the need for more spending in the future.

Where The U.S. Leads the World (Almost)

March 13, 2013

According to a report by KPMG, the U.S. has the second highest corporate income tax among all nations.   I don’t know what the workforce is like in Vanuatu and I am not certain how I would feel about worshiping at a shrine that is the remnants of a wrecked WWII B17 bomber, but if those aren’t concerns to you they have a 0.0% corporate tax rate.  So also do Bahrain, Georgia, Saba, as well as some well known industrial powerhouses such as the Bahamas, Bermuda, and the Cayman Islands.

That we (the U.S.) have almost the highest statutory corporate tax rate in the world is the focus of a lot of debate in Washington, but what is probably more relevant is the dramatic differences in the effective tax rates of different industries in the U.S..  Aswath Damodaran, Professor of Finance at the Stern School of Business at New York University, calculated the average tax rate of various business sectors using public financial statements.  The chart below illustrates the disparity between the average tax rates  paid by different sectors of the U.S. economy and includes only the highest and lowest twenty industries.  My purpose isn’t to single-out any industry or group of industries so the chart isn’t a commentary on the merits of any particular industry, I’ll let readers make their own assessments about the implications of varying rates on different industries.    The chart shows the average rate based on the public filings of over 6,000 publicly traded companies and includes only the rates  for profitable companies.    Effective marginal rates would be better to show but public data does not allow for that estimation.

Tax rates by industry

Unfortunately, it does not seem that the high level of concern about the world  ranking of  the U.S. corporate tax rate is matched by a concern about the large differences in effective rates by industry.  A lot of people are all for reducing the statutory corporate rate in the U.S., they just aren’t so keen on reducing or eliminating  the $100 billion + in preferences and breaks that could pay for it without adding to the nation’s deficit.

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