SHI 10/4/17: Their Own Set of Facts

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September 27, 2017
SHI: 10/11/17 Are Asset Values too High?
October 11, 2017

The tax plan, as proposed by the Trump administration, could bankrupt the US.

 

“Everyone is entitled to his own opinion, but not his own facts” … is a famous quote from the infamous Senator Pat Moynihan.   And spot on.    Especially today, when the Administration offers up its new tax plan.    Both Gary Cohn and Steve Mnuchin claim — at worst, the tax plan is deficit neutral — and may even generate enough new taxes from GDP growth to reduce the national debt!

Sorry, Mr. Cohn and Mr. Mnuchin, but your “facts” are pure fantasy.  Downright insane, frankly.  If the tax act passes as proposed, I have grave concerns the level of our US debt will skyrocket in the next 10 years.   Possibly beyond the tipping point.  Let me explain.

 

Welcome to this week’s Steak House Index update.

 

If you are new to my blog, or you need a refresher on the SHI, or its objective and methodology, I suggest you open and read the original BLOG: https://steakhouseindex.com/move-over-big-mac-index-here-comes-the-steak-house-index/


Why You Should Care:   The US economy and US dollar are the bedrock of the world’s economy.   At present, is the US economy expanding or contracting?  We need to know.

The world’s GDP is about $76 trillion.   At last count, our ‘current dollar’ US GDP is now over $19 trillion — about 25% of  the total.   No other country is even close.

The objective of the SHI is simple: To help us predict US GDP movement ahead of official economic releases — important since BEA data is outdated the day they release it.

‘Personal consumption expenditures,’ or PCE, is the single largest component of US GDP — about 2/3 of the total.  In fact, the majority of all US GDP increases (or declines) usually result from (increases or decreases in) consumer spending.  Thus, this is clearly an important metric to track.   The Steak House Index focuses right here … right on the “consumer spending” metric.

I intend the SHI is to be predictive, anticipating where the economy is going – not where it’s been. Thereby giving us the ability to take action early.


Taking action:  Keep up with this weekly BLOG update.

If the SHI index moves appreciably -– either showing massive improvement or significant declines –- indicating expanding economic strength or a potential recession, we’ll discuss possible actions at that time.


The BLOG:

Cohn believes lowering the corporate rate will make the U.S. more competitive for development globally, which in turn will drive productivity, wages and employment that will get growth above its current sluggish trend.  Maybe.

Speaking on Thursday of last week at the Washington Ideas Forum, Mnuchin said he expected the tax reform will kick GDP growth up to between 2.9 percent and 3.2 percent annually over 10 years, later emphasizing that he was “very comfortable that we can get to higher than 3 percent.   Again, maybe.

Let’s separate opinion from fact.  While much is not yet know, let’s work with what we do know.

For the moment, let’s assume the proposal passes as it.  The plan calls for a reduction in the top corporate tax rate to 20% down from 35%.   The plan would also bring the top rate for “pass-through” businesses (sole proprietorships, partnerships, and S corporations) down to 25% from its current level of 39.6% (or the proposed highest individual tax bracket, 33%).

The one thing this plan would do — for certain — is increase all corporate profitability — public and private.   This is one reason the stock markets have been soaring of late.  The markets are expecting this bill to pass, in some form.

 

Which means, conversely, if it doesn’t, the stock markets may see a HUGE decline.

 

What will corporations do with the additional earning?   Cohn and Mnuchin believe they will reinvest into more plant and equipment.  Perhaps.   In fact, the new tax plan is designed to motivate this choice:   It proposes a corporation may deduct the full cost of investment into plant and equipment in the tax year the investment is made.  This provision is likely to spur increased investment.

Or the company might distribute the profits to shareholders as increased dividends.   Or they could keep them as additional retained earnings.

But, for the moment, let’s assume corporations reinvest increased earnings and POWER UP the GDP — all the way up to 3% per year, for the next 10 years.   Assuming our current run-rate is roughly 2%, we’d see a 1% GDP increase every year.   In dollars, rounding up a bit, that equates to a GDP increase of almost $2 trillion per year! 

Now, let’s talk taxes.   Or, as the Treasury calls them, “receipts.”  Historically, what percentage of GDP becomes receipts for the Treasury?  Here’s a chart, courtesy of the St. Louis FED, dating back to when records began, around the time of the Great Depression:

 

 

Note the top line is 20%.    Clearly, federal tax receipts — from all sources — have been consistently below 20%.   In fact, according to the OMB Historical Tables (Table 1.2), receipts have only equaled or exceeded 20% twice — once in 1944 and once in 2000.   Never before or since.

But let’s be generous:  Let’s assume, for the moment, this annual $2 trillion GDP increase does boost Treasury receipts by 20% of the GDP increase — or $400 billion — each year.  Will this cover — or exceed — the cuts created by the new tax plan?

If we were only talking about publicly traded corporations, maybe.  Because tax receipts on corporate income are around $400 billion a year.   Meaning a cut from 35% to 20%, in theory, would cost the US Treasury about $170 billion per year.   In fact, the loss of tax receipts would be lower.  While the statutory corporate tax rate is 35%, many corporations actually pay quite a bit less.  So, if we did see a 1% increase in GDP from a corporate tax policy change, this change in tax policy might actually be revenue neutral. 

No, the bigger issue is the proposed change to how ‘pass-thru’ entities are taxed.

Ironically, we’ve already seen how such a plan might work.  For about 5 years, the state of Kansas tried a version of this plan.  The Kansas plan eliminated taxes for ‘pass-thru’ entities.   Kansas, like the Trump administration, felt the tax rate reduction would stimulate the Kansas economy thru increased spending and job growth.  Nope.  The plan failed miserably, adding billions of dollars in budget shortfalls, and significantly increased Kansas’ state debt load. 

In June of this year, the Kansas State Legislature completely scrapped the experiment.  And they’re now requiring business to pay retroactive taxes for 2017.  Ouch.  In Kansas, during the time of this “experiment,” new ‘pass-thru’ entities were formed at record rates.   Tax payers wanted to take advantage of the new law and reduce their personal tax burden.

It’s likely the Treasury won’t make a similar mistake.  I hope.  At least not to that extent.  But this change will impact Treasury receipts from ‘Individual Income Taxes’ — which, as you can see below, amount to 47% of all receipts.  I can’t forecast the impact … but I don’t think it will be positive.

 

 

In fiscal 2016, individual taxes were about $1.55 trillion.    About 150 million taxpayers file returns each year.  About 1/3 have no tax liability.   Folks earning over $250,000 (AGI) in 2014 paid about $700 billion in taxes.

Suppose the new tax provisions motivated some of these folks to become a ‘pass-thru’ entities in order to cut their personal tax bill?   Much like what happened in Kansas?    Imagine a taxpayer in the highest bracket — under the new plan, 33% — who can save 8% by converting to a pass-thru?   Might they find a way?  Certainly.

Oh, you may be thinking, that won’t happen.  I’m certain the US tax plan would be designed to prevent that outcome.  Perhaps, but I don’t see how.

The lost tax revenues could be trillions.   In fact, the nonpartisan Tax Policy Center estimates the lost revenue under this plan would exceed $5.6 trillion over 20 years.   I disagree.  It will be much more.   Once the true cost of this plan becomes clear, and the deficit balloons, US interest costs could also skyrocket.

This plan has serious math problems.   Sure, it may not pass the Senate and House.   As written.   I hope not.   If this plan were implemented, the result could well be a disaster of epic proportions.  Not right away … but in the decades to come.

OK…I’m off the soapbox and off to the Steak House!   I have no doubt, a tax cut would stimulate additional consumer spending in steaks and potatoes.   Are pricey steak-lovers consuming more steaks?  Not really, is the short answer:

 

This week, the SHI reading is a negative <-12>.   Which is only 6 points lower than this same time last year.  Once again, Mastro’s Ocean Club is fully booked, and our other expensive beauties are quite available.   Here is our longer term trend.

 

 

For weeks now, the SHI has been in a tight range, indicating a weak Q3, 2017 GDP growth rate.   After a quick look at the ‘nowcast‘ from the NY and Atlanta FEDs, we find their methodologies, too, are currently predicting a more paltry Q3 GDP growth rate:  On 9/29 the NY forecast was 1.46%, and on 10/2, Atlanta was forecasting 2.7%.   A wide divergence.   Clearly, the folks in New York need to “ketchup” with Atlanta.   🙂

I know, bad pun.  Sorry.  Not really.  And both readings are down significantly from much higher prior ‘nowcast‘ readings.

Remember that the SHI and Steakonomics were never intended as a precise GDP gauge, but more as a barometer for trending in consumer spending.  And the SHI is predicting that trend is slowing.   The jury is still out on SHI efficacy.   But hurricanes notwithstanding, it is interesting to note that both FED nowcasts are much lower, now, than in prior weeks.

A final comment on the tax proposal.   The great George Santayana once commented, “Those who cannot remember the past are condemned to repeat it.”  

America is too important, to amazing, and too unique to permit such a risky tax proposal to become law.    Sure, some aspects may be smart to implement — specifically the 20% C-corp tax rate and related provisions.  These changes have a chance to be revenue neutral — and might offer a GDP boost.  A well-designed revision here could benefit the US economy.  

But the ‘pass-thru’ concept, as proposed, is pure lunacy.

Across the centuries, history is filled with the empty husks of failed societies.  Economies of countries once great subsequently crushed by poor leadership and repeated bad choices, without any real understanding the long-term implications of those choices.   I only hope this great country of ours can avoid the same fate.  I am concerned.

  • Terry Liebman

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