728x90 AdSpace

Latest News
April 26, 2015

Tax Receipt: Fantasy vs. Reality

By Lance Roberts at Street Talk Live
With "tax day" now firmly behind us, it is expected that 2015 will show a record level of tax collections. This is a good thing, right? Maybe not.
Over the weekend, an economist friend of mine sent me an interesting piece of analysis discussing the record level of tax receipts as a percentage of the economy. This is something that I have written about in the past.
While the current push higher in tax collections partially due to economic growth, it is primarily due to higher tax rates brought on by the "2011 Budget Control Act." That bill imposed automatic tax increases and spending cuts beginning in 2013. It is worth noting that then chairman of the Federal Reserve, Ben Bernanke, launched "QE 3" specifically to offset the potential risks of the "fiscal cliff" imposed by the "debt ceiling deal."
The good news is that those tax increases and automatic spending cuts led to a massive shrinkage of the deficit which has declined from a record of $1.35 Trillion in 2010 to just $559 billion as of the end of 2014.
While it is certainly good news that the budget deficit is shrinking from a "fiscal"perspective, the economic ramifications are not so great.

The reason: "The economy is not growing strongly enough to offset the drag caused by fiscal austerity."
Government spending was a support of economic growth prior to the onset of the fiscal cliff. While the President currently takes credit for the shrinkage of the deficit, it was due to no actions of his own but rather a complete "SNAFU" brought about by the ongoing guerilla warfare between the Democrats and Republicans.
The austerity measures automatically imposed by the Budget Control Act of 2011 became a drag on economic growth as the rise in tax collections reduced the consumptive/reinvestment effect of those dollars in the economy. The chart below shows the surge in tax receipts as a percentage of GDP.
(Note: The surge in receipts at the end of 2013 was due to a massive payout in bonuses and dividends due to the onset of the "fiscal cliff" in order to take those funds at lower tax rates.)

While raising taxes may increase revenue in the short run, over the longer term higher tax rates leads to lower economic growth. As stated, if more dollars are extracted through taxes, there is less available for consumers/corporations to utilize. Furthermore, while tax dollars do get recycled back into the economy, repeated studies have shown that government spending has a much lower "multiplier" effect as compared to dollars spent directly by consumers and businesses. Note in the chart above that taxes as a percentage of GDP have historically peaked between 18-20%. Now, let's compare that to actual economic growth rates.

I have highlighted the periods when receipts as a percentage of GDP have peaked. There are two things worth noting in the chart above. Rising levels of receipts have coincided with stronger levels of economic growth in the early stages which is not surprising as more revenues lead to higher collections. However, once those collections exceed 18% of GDP, it has generally marked the peak of economic activity and a subsequent recessionary drag in the economy.
There is one other point to be made. While there are many calls to raise taxes on the rich, give more to the poor, what the chart shows is that none of that really makes much difference. Regardless of the level of tax rates - tax receipts as a percentage of the economy has remained mired between 16 and 21%. Why? Because when you raise taxes, you lower economic growth and, therefore, collect less in revenue. During recessions, tax collections are at the lower end of the range while during expansions collections are at their highest.
So, what does all of this mean? As Tom McClellan recently noted:
"As Arthur Laffer noted 3 decades ago, it really is possible to set tax rates too high such that it actually hurts the economy.  We appear to be in such a condition now. I wrote about this topic back in January, when lawmakers were contemplating raising the tax on gasoline.  But it is worth revisiting as we see total federal receipts creeping up toward 18% of GDP.  Whenever total federal tax receipts have exceeded 18% of GDP, the result has always been a recession for the U.S. economy."
The chart below shows receipts as a percent of GDP as compared to the S&P 500 index. Note that each peak in tax collections has coincided with a mean-reverting event.

While there are many that expect that the markets can repeat the secular bull market of the 90's, and by extension receipts could test the previous high, Tom makes a salient point as to why this is not likely.
"In 1999, the members of the Baby Boom generation (born 1946 to 1964) were between 35 and 53 years old, in the peak of their entrepreneurial years.  They were working hard, building companies, and pushing the economy faster than it would normally go.  Now, they are 51 to 69 years old, and are more interested in playing with their grandchildren than in starting a new company and hiring people.
The children of the Baby Boom generation make up what is known as the 'Echo Boom', which peaked in the birth year of 1990.  Those 1990 babies are now just 24 to 25 years old, and many are just now moving out from their parents’ homes. So they are not quite at their peak of hard work and entrepreneurialism, and even when they do reach that point, their numbers are just a shadow of their parents’ generation. So the Echo Boomers cannot absorb the same degree of a repressive tax burden that the Baby Boom generation could."
This, along with a variety of other reasons I have addressed previously, suggests that the current economy and market are likely at their later stages of expansion currently. As Tom concludes:
"And we need to keep the federal receipts number well below 18% if we are to avoid the next recession, and its associated downturn in stock prices.  We may already be too late in that regard."
Tax receipts are clearly issuing a warning sign. However, as is always the case, you can NOT make short-term investment decisions based on very slow-moving economic variables. This has been a common mistake made by investors. Irrationality and exuberance, along with massive Central Bank interventions, can keep asset prices inflated for far longer than logic would dictate. This is why technical analysis of price trends is so critically important to understand over the near-term.
It is unlikely that stocks have "reached a permanently high plateau," or that this time will resolve itself differently. Eventually, reality and fantasy will once again reconnect and throughout history it has never been reality doing the "catching-up".
Read: The Evil 1% And Failure To "Pay Their Fair Share"
Courtesy Lance Roberts at StreetTalkLive.com (EconMatters author archive here)
The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters. © EconMatters All Rights Reserved | Facebook | Twitter | Free Email | Kindle
  • Blogger Comments
  • Facebook Comments
Item Reviewed: Tax Receipt: Fantasy vs. Reality Rating: 5 Reviewed By: EconMatters