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Friday, January 28, 2011

Our Position Does Not Improve

2010 Advance Q4 GDP was released today.

There was a huge inventory drawdown or GDP would have been far above 3.2% annualized for the quarter. Usually an inventory drawdown bodes well for the next quarter, because it means that production will have to ramp up and jobs, hours and material purchases ramp up. It is not quite clear that this will happen as fast as one would hope due to the durables report.

But fiscally speaking, this report had little but bad news for the future. PCE grew 4.4%, accounting for all the growth. Gross private domestic investment went negative, but only on the inventory draw.

Is this type of personal consumption growth even remotely sustainable?

Looking at personal incomes one would say not:

Wages are slowly clawing out of the depths, but there is trouble ahead.

Looking at ratios explains why:

Government benefits paid (current transfer receipts) are exceeding personal taxes and payroll taxes. Obviously this is not sustainable over the longer run.

While a portion of the government payments related to the recession (food stamps, unemployment insurance, medical assistance) will slowly fade presuming additional growth, it will be replaced by the ever-growing retirement expenditures.

In particular, over the next few years several million retirees will become eligible for Medicare benefits. And then it really gets bad.

So taxes must be increased, but this is why I made this time series. Note that the red line (representing payroll tax plus personal tax) does drop with the Bush tax cuts and then the Obama tax cuts (which were increased very substantially this year), but even with the Bush + Obama cuts, taxes plus payroll taxes only fell to ratios approaching the early 1980s. The reason is that although personal tax rates were dropped (most substantially for lower income earners) payroll taxes were sharply increased. Indeed, unemployment taxes went up, so once this year's payroll tax expires payroll taxes will be at their highest rates ever.

Worse yet, wages are being suppressed by supplements. Wage and salary supplements are composed of two slices. The first are payroll taxes (Medicare, Social Security and Unemployment). The second are employer payments for private insurance and retirement funds. Costs for insurance are going up so rapidly that even with cost-shifting to the employee in the form of wage deductions, the ratio of government supplements to private supplements keeps dropping.

Anyway, it is clear that personal taxes are going to be raised. Obviously this will leave less income for consumption.

If you look at Table 10 (Personal Income and its Disposition) in the GDP release, you see that Q4's annualized personal income in real dollars ex government transfers was 9.308 trillion compared to 2008's 9.638 trillion. If you look at BEA's time series, you see that 2010 Q4 is back to 2006 levels in real dollars.

Part of the problem is that income from interest and dividends is still down from its peak. Personal receipts on assets (interest and dividends) peaked at 2.1X trillion in 2007 Q4 - 2008 Q3, and in 2009 Q4 had only rebounded to 1.9 trillion. In 2008 Q1 government transfers were almost 1.8 trillion. In Q4 2010 they were 2.3 trillion.

Wage and salary disbursements (wages paid to individuals, not counting supplements) peaked at almost 6.6 trillion in Q1 2008 and had only rebounded to just under 6.5 trillion in Q4 2010. Proprietor's incomes have not rebounded yet either. The only income category up is rents, which is at a new high. Not surprising, given the fall in home ownership.

There's more going on here than meets the eye - the remarkable shift in supplement ratios indicates that insurance costs are probably suppressing private salaries quite strongly. Hence CBO's new projection for continuing Social Security deficits.

Instead of digging a deeper hole by taxing the citizens
Who are productive, the government needs to cast a wider
net with tariffs. Companies would either eat the cost to
stay competitive, or they would shift production here.
Raising tariffs on imports will affect exports. Might also affect demand for bonds.

There is no easy solution.
Great post, M_O_M. Question: has the ratio of government benefits to wages paid ever increased so fast (looks like + 33% in under four years) historically? Or is this a sign that we're pushing the limit of the Meltzer-Richard hypothesis?
Carl - it is obvious that we are.

On the lower end of the retiree income spectrum, SS is a replacement for welfare (SSI, food stamps, etc).

Cutting SS for those people won't save any money at all.

Pretty evidently, taxes for the middle class and upper class will have to be raised, and benefits for the middle class will have to be cut.

There is no other way out. If we let this go to the point at which debt has already accumulated to 90% of GDP, then we just slam into the wall suddenly and then the middle class is going to be faced with much worse cuts.
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