Monday, October 22, 2007
I swore to myself that I'd get this done last week. Nothing like missing another deadline, eh? This is a graph of the Rockefeller Institute sales tax data. Right click on the graph above to get a larger version opened in another tab or window. If you don't do it, you won't really be able to follow the rest of the post.
We don't have third quarter data yet, and won't for a couple of months. Rockefeller Institute sales tax data is very high quality. What you see graphed above are receipts adjusted for legislative changes compared to receipts adjusted for inflation. Note that motor fuel taxes are excluded. The inflation adjustment used is the implicit price deflator for state and local governments, not the CPI.
What's important here is not just the positive/negative change, but also the difference between inflation adjusted (real) and the nominal change. Sales taxes are charged to end users, although details can vary from state to state about which business purchases have exemptions (purchases for resale are exempt). Also, some services in some states are subject to sales tax. Thus the sales tax numbers incorporate both consumer and business spending. The 2001 recession was really caused by a drop off in commercial spending, and you can see how quickly it moved.
The reality is that whenever the difference between real and nominal sales tax receipts is quite positive over a year, there is a positive feedback loop into the economy. When they come close to equivalence averaged over a year, it generally presages either a significant downturn if the relationship has been positive, or the beginning of a significant economic growth pattern if the relationship has been negative. This is because when real receipts stop growing, corporate profits are constrained and job growth will be constrained, and when real receipts have been dropping but then stabilize, the spending growth pattern is beginning to shift to a positive feedback loop through the economy.
You can see the last two recessions in this graph, as well as slowdown periods. You can also see the effect of Katrina in the last half of 2005. We really never managed to climb out of that effect, although no one expected that at the time. In addition, MEW has been so high that it has added a significant amount of spending power to the economy, so the small difference between real and nominal spending as measured by sales tax receipts is remarkable over the last two years, and in many ways it is due to weaker business spending.
Naturally enough, the decline of construction and the credit problems are exerting a downward thrust of their own, and no matter how many economists say that income increases are providing impetus, it's obvious from these figures that income isn't providing much in the way of real spending growth. If you take the YoY change for these figures, the situation becomes even more obvious. See the graph on page 3 (pdf) of the Rockefeller Institute's last publication to understand how close to the zero line we are walking. YoY growth of 1.9% is only about 1% over population growth (estimated as .9%), which is far too little to even be certain that real spending is growing.
In the third quarter, things got worse. Additional states are reporting sales tax nominal drops. Georgia and California rolled over, for example, and I believe Pennsylvania went YoY negative on some measures. There are quite a few more. This is not a good sign, because the second quarter was clearly very, very weak.
As of the second quarter, the following states showed negative adjusted (for legislative and inflation) total tax revenue growth (you can get this from page 6 at the above link). Total tax revenue in this report excludes fuel taxes, but includes personal and corporate income tax receipts as well as sales taxes:
MaineIt's a remarkable phenomenon that the construction weakness has not shown up in jobs nearly as much as in corporate and personal tax receipts. I would say that this is due to both declining margins and a largely unreported loss of jobs in construction. Most construction is subcontracted to firms that aren't picked up by the establishment survey, and much of the growth of construction employment was filled by illegal aliens who don't even have household phones and are certainly not going to discuss household information with some phone surveyor. Thus they don't show very much in the household survey either.
A further downturn is more than the economy can bear, so I would say that the recession is here. I was willing to call it in the second quarter, because while nominal figures look much stronger than inflation-adjusted, the inflation itself seems to be causing a lot of the weakness. Retail is clearly having a very tight year, and job growth for retail has shown that weakness over the last eighteen months. I do believe that we rolled over into the arena of unrecoverable weakness in the second quarter.
There are other factors that show what is happening in the economy. Demographics are little discussed, but inflation's impact upon older individuals, most of whom are living on relatively fixed incomes, just leaps out from the numbers if you look at state data (go to page 6 in the link!) combined with state demographics. Populations with larger cohorts of lower income or older individuals show significantly more weakness. The YoY relative growth patterns in the retail sales report show a marked shift in spending toward necessities and away from discretionary.
Not all states impose sales taxes. Most of those who do exempt food from sales taxes. You can find a list of states which impose sales taxes on food here, and if you look at the second quarter sales tax receipts by state in Table 3 on page 5 of the Rockefeller publication, you see that, on average, these states showed stronger sales tax revenue than regional states which don't, especially when you adjust for legislative changes.
So what are we looking at going forward? Well, the California sales and use tax figures pretty much tell the tale. September 2006 compared to September 2007 show a YoY decline from 2,090 mil to 1,929 mil in 2007. Unemployment in California is now up to 5.6%, and we are certainly seeing the effects of that.
The effect on government employment will probably be one of the substantial factors going forward. Over the last year, government and public-financed employment has been a much larger contribution to employment growth than private in many areas. But state tax revenues are weakening substantially in too many states for government employment to continue carrying this load.
In the last couple of weeks, we have seen gas prices decline slightly, but no one seems to think that can continue. If gas prices reach $2.90 on average by November, it's going to be very ugly. Diesel prices continue to rise, indicating that price inflation in stores will resume.
The current economic downturn is quite different from the 2001 downturn (which really began in 2000). I call it "slow, creeping and consumer-led" because it is consumer spending which is the major cause. The credit crunch and the end of the housing boom would not cause a recession now if real consumer incomes had been keeping pace with inflation. But they haven't been, and for years now growth in consumer spending has been funded by debt. Since late 2005, the combination of relatively high consumer debt and high consumer inflation has pushed the real growth in the economy down to a narrow floor, and the contributing factors of the relative credit contraction and diminished construction spending and job growth are just undercutting the support from that low rate of growth. This whittling process will continue.
It's very unclear at this point whether cutting Fed rates will do much to change the fundamentals of this economy over the short term. I believe the Fed knows this very well. One can talk about real income growth, but the reality is that higher benefit costs (often for lower benefits) are converting that real income growth into smaller or barely rising paychecks for upwards of 40 million employees, who then head off to the gas station and grocery store and face very real inflation. If cutting rates causes a cheaper dollar, fuel prices will continue to rise, which hits companies selling to the US consumer rather intensely. The Fed has a very limited scope of action. It can cut only if it has the margin to do so in comparison with other global economies. Money moves globally, and the Fed cannot stimulate growth in the US economy unless it preserves some ability of the US economy to attract investment.
The combination of high consumer debt loads and high inflation is a very difficult one for any economy to overcome. For many US companies, high debt loads accumulated during times of cheap credit are now coinciding with lower profit margins, so it is highly doubtful that companies whose spending was contributing substantially to growth in the domestic economy will sustain their spending. An example of this are changing plans for retail and restaurant chain expansion.
Duration of this high consumer inflation is also a factor. For the first year or so, many consumers considered it temporary and were willing to keep spending by using credit in one form or another. There are growing indications that this attitude has changed significantly over the course of 2007. There is no question that many of the refinancings which traded higher rates for lower payments and higher principal balances were done to pay off other consumer credit. This presages further problems with auto and credit card loans, making it likely that credit standards will tighten incrementally over 2008.
Headless Unicorn Guy
You might want to check out this post. I've charted the building materials sales and adjusted them by population and the CPI.
Headless - OUCH! You are in the OC area, right? I just looked at the map and right now no fires, right? It will offend many, but we here in GA have added SoCal to the rain prayer list. It's a hell of a note when you are afraid to go to sleep because the winds might shift your way.
Mark, I think building supplies have a long, long way to go down. My guess is that the bottom will be in 2009.
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