Tom McClellan writes last week about a predicament the US fiscal policy has created. There are no answers offered but there is a heads up for investors. Tax receipts may fall soon and stay there for two years after the Presidential elections. Here is what he writes and a link to his blogpost.
The U.S. is racing up toward the "fiscal cliff", a horrible deal agreed
to by both houses of Congress that is so terribly unthinkable that the
two sides which agreed to it figured no one would ever let the situation
proceed to that outcome. Now both sides are playing "chicken", as the
deadline zooms toward us. Those who are advocating austerity of federal
spending don’t have a genuine understanding of the severity of cuts
that would be needed to balance the budget. And those who think that the
problem can be solved through higher tax collections are similarly
clueless about just how much money can be reasonably brought in.
The chart above helps us to see this point more clearly. The price
plot of the SP500 is shifted forward by 12 months to reveal how total
federal tax receipts tend to rise and fall as an echo of what the stock
market does. The drop in stock prices during the summer of 2011 says
that tax receipts should see a similar stumble (on a 12-month basis),
and the tepid rebound says that tax receipts on an annual basis are not
going to get much higher than what we have been seeing. And if the
stock market follows its typical path for the first two years of a new
presidential term (2013-2014), then we cannot expect to see the stock
market bend the tax collections curve much higher for the next couple of
The whole reason why this is so important has to do with the vast
spread between receipts and expenditures, as shown in the chart below.
Each is expressed as a percentage of GDP, to help us better see the
magnitude of both of them.
Over the past 12 months, the federal government has spent money at a
rate equivalent to 23.4% of GDP, while it has only taken in money at a
rate equal to 15.2% of GDP. Saying it another way, expenditures have
been 153% of receipts over the past year. That is clearly not
sustainable, with total debt per taxpayer now at $139,297 and rising.
And neither is it something that can be made up by tax increases
alone. To equal expenditures, tax collections would have to increase by
53%. The SP500's predictive model says that expecting taxes to ramp up
that high is just not supportable. It is not even a supportable idea
to think that total annual tax receipts could get up to the April 2008
high of $2.6 trillion, since the SP500 has not been able yet to equal
its 2007 high.
The current 12-month rate of tax collections sits at 15.2% of GDP.
Every time that this rate has gone above 18%, it has pushed the U.S.
economy into a recession. So Congress cannot get us to a balanced
budget through tax increases alone, since expenditures are currently at
23.4%, or more than 5 percentage points above that recession threshold
level. Politically speaking, spending less is really unpopular. Nobody
wants to volunteer to be the marginal recipient of federal
expenditures, just as nobody likes to be the marginal consumer of food
during a famine.
But the two plots have to somehow be nudged closer together if the U.S.
is to survive in the long run. The tax collections plot cannot
reasonably be expected to rise above 18% without pushing the U.S. into
another recession, the usual response to which is for Congress to cut
taxes. In other words, "you can't get there from here" via tax
And members of Congress cannot reasonably expect to get themselves
reelected if they cut off access to the Federal punch bowl to the degree
needed to get these two lines together. Too many special interests are
expecting to continue receiving what they have become accustomed to,
and they will vote out anyone who yanks away that punchbowl.
It is indeed the thorniest of problems.
Editor, The McClellan Market Report