The biggest myth being promulgated today is that the economy must be doing better because state & local government revenues are on the rise. Dude! That’s not the economy! It’s called tax increases. In fact, 23 states have boosted taxes in the past year. Eight have even raised income taxes!
I want to take the opportunity and wish you all the best for 2011. To health, happiness and prosperity — especially in risk adjusted terms.
10 From a historical standpoint, the yield on the S&P 500 (2%) is very low. This smacks of a market top and underscores the point that the market is too optimistic; investors are willing to forgo yield because they assume that they will get return via the capital gain. The last time S&P yields were this low was in the summer of 2000, and we know what happened shortly after that.
Our annual deficit is 10% of GDP. A deficit of 3% is sustainable (trust me) and 2% of the deficit will melt away as the economy revives; leaving a deficit of 5%. Had the Bush tax cuts been repealed that would have reduced the 5% to 2.5%. What this means is that Congress has to find twice the value of the Bush tax cuts to get us to a stainable fiscal level. It may take a decade for voter to digest this.
There will probably a nasty spending fight in ’11 complicated by the need to raise the federal debt limit to avoid a default; a vote many new Republican have indicated they would not make. Republicans say the debt limit vote offers a chance, allowing them to tie a package of spending reductions to the debt increase to make it more palatable. The fight will do great harm.
If there is a positive theme that transcends the weak U.S. economy it’s ag! Farm incomes are way up & indications suggest more increases in ’11. This is due to increasing demand for food, especially proteins, from rising living standards in China, India and other emerging economies. The latest evidence of this was in the Fed’s Beige Book which provided some fine treats to chew on when discussing US food production.
Yields on Greek & Spanish bonds (credit downgrade looms) are up; Irish bond yields are also up to 8.4%, which, in real terms is over 10%. Something is going to give because that is unsustainable when real GDP is CONTRACTING at a 2% rate. In the old days currency devaluation & debt restructuring would have occured by now. And with GDP growth in Germany expected to slow the Euro is clearly not the place to be.
2010 NOV U.S. retail sales up 0.8% but Autos down 0.8%, Furniture/appliances down 0.5%, Electronics down 0.6% & Building materials down 0.1%. What was up? Groceries 0.8% Gas 4.0% Drug stores 0.9% & Clothing 2.7% What we had was a surge in “necessities” which rose 2%, the largest increase since Nov 09. Either there is a seasonal need for more toilet paper, macaroni and fuel in November or the public is feeling poor.
There is tremendous econometric evidence strongly suggesting that only tax cuts that are perceived to be permanent contribute to spending — people do not alter their behavior based on temporary changes to their income, wealth or job. Temporary tax cuts, which the payroll reduction is, go into savings. This is where economists who are aggressively boosting their forecasts — as they did in 2008 — may be wrong again.
Some economists say higher income taxes keep people from working. This is the substitution effect–because leisure becomes relatively cheaper people consume more of it. But higher taxes also reduce after-tax income so one might work more due to higher taxes. This is the income effect. The question is whether within certain ranges of tax rates, raising taxes increases or reduces effort. Theory gives no clear answer.