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Friday, June 25, 2010

GDP Third Estimate

Yeah, yeah, I know it's supposed to be final, but in fact these get revised for years, so I like my term better.

The full report in pdf is here.

Headline is +2.7% (annualized).

The underlying numbers after adjustment for inflation/deflation:
Now for the ugly details:
The implications going forward for the second half of the year:
I regard this report as confirming my claim that trend growth is under 2%. In fact, I revise trend growth to 1.5%-1.7%. That is scarily low. Call it a Halloween scenario.

Here the BP disaster enters the picture. Because much of increased supply comes from ocean drilling and synthetic oils (such as those produced from the tar sands + natural gas in Canada), costs of acquiring new supply have to be the underlying driver for long term oil costs. And the reality is that costs for ocean drilling probably just incurred a long-term increase. I would say that probability is about 99%, but there may be something I don't know, so take that with a grain of salt. I'm pegging that somewhere around 10%, which would imply that oil's likely base price going forward is somewhere around the low 70s. And that's a structural change which raises transport costs and production costs.

In addition to that, China's manufacturing is clearly going to be pushing some increased costs due to the increased cost of oil and increased wages. Manufacturing wages in China have to grow on inflation (and the monsoon in India has slowed and may produce a higher rate of inflation in India than expected a month ago). Inflation in China and India is fundamental to the world economy.

So here is the nightmare scenario for governments. We have a structural budget gap. If we raise taxes, we reduce PCE, which reduces GDP growth. But with trend growth so low, and PCE growth likely to moderate anyway, we really can't afford to reduce PCE by fiat because we'll produce a second contraction, which will certainly not help government revenues.

For voters, this is also a nightmare scenario, because we have nowhere to run in the current parties. What will work in this environment would be a mix of Republican/Democratic strategies. Right now that mix appears politically unobtainable. All taxation is not the same. In a situation in which growth is dependent upon bolstering investment, certain taxes should be cut and can be compensated for with raising other taxes. But we don' t have a party that is willing to do it.

Right now we are growing and can maintain growth, but only weak growth. As soon as current legislative initiatives start to be felt in the real economy, we'll slip into another contraction.

Comments:
What will work in this environment would be a mix of Republican/Democratic strategies. Right now that mix appears politically unobtainable.

By which I assume you mean we should reduce taxes on cap gains, dividends, and business income, while we raise taxes on individual income starting with a low tax bracket. You've also said in the past that we should reduce or eliminate the deductions for municipal bonds and Treasuries, I think.

I'll bet that would work, but I've seen little indication so far that Americans are willing to take it.

Democrats absolutely will not do it--their campaign donors depend on the advantages conferred on the politically-connected by high tax rates on growing competitors. Republicans probably would do it, but Americans won't sit still for having their individual rates increased while "fat cats" have theirs decreased. So the Republicans try to sell growth by claiming everybody can have lower rates, which ain't true in this environment.

I suspect things must get much worse before we're willing to do the obvious things.
 
Oops-by "raise taxes on individual income", I should have pointed out I agree that the 1% to 2% increase in Medicare taxes you've talked about would do the job pretty well.
 
Neil - we can't raise income taxes on low tax brackets. I do think we have to do the Medicare tax increase, but that's all that the vast majority of households can stand.

But we should cut capital gains. Unhappily, most of that is now an inflation/property tax. It's totally counterproductive.

And we absolutely do need to raise taxes on some income that is now tax-sheltered (over certain levels). We want to avoid the trap where people won't be able to accumulate capital.

And not to belabor a point, but our current strategies are abusing savers and impairing their ability to accumulate capital. If you are an average person, getting less than inflation on your savings makes life very difficult.

And any further income tax increases should be small. You'll get better returns on small increases but start them far below the 200K level they are discussing now.

The last thing we should do is a VAT. It's a huge cost multiplier for businesses, and it's regressive as all hell. Might as well just declare war on the working/middle class and be honest about it.
 
Thanks for the clarification, M_O_M, and I agree the rate increases would be small, if the tax base is broad enough. A percent or two on Medicare, a few percent on income tax (down to what, $60K-married?) and that's about it, I bet. Tax munis, tax Treasuries, tax SS checks as regular income (though not payroll), and you're there. I don't know about 401k's. Let private investment take care of the rest.

Of course, you've also got to roll back a bunch of silliness from the last couple of years--but that's another story.
 
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