Tax Time

Tax Time – The Treasury Department reported that the federal deficit totaled $691 billion for the first half of FY19, up from $600 billion for the first half of FY18. The full-year deficit (ending in September) is expected to hit $1 trillion.

Tax receipts were up 0.7% in the first six months of FY19. Individual tax receipts were down 1.7%. Corporate tax revenues fell 13.5%. Payrolls taxes rose 4.7%

Federal outlays rose 4.9% y/y. Defense rose 13.6%. Medicare rose 3.3%. Social Security payments were up 5.6%. Interest on the debt rose 14.8%. Spending on everything else fell 2.9%.

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When talking about the budget, the dollar levels can be intimidating. It’s best to look at the figures as a percentage of GDP. The deficit hit 10% of GDP in the early part of the Great Recession. That reflected the magnitude of the downturn. Tax receipts dried up and recession-related spending (food stamps, unemployment benefits) rose. President Obama had requested, and Congress approved, a large stimulus package in 2009, which partly added to the total, but that was temporary. As the economy recovered, the deficit fell.

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In the last few years, revenues have trended about flat, while outlays have continued to trend higher. However, as a percentage of GDP, outlays have trended roughly flat, while tax receipts have declined.

The Tax Cut and Jobs Act of 2017 (TCJA) lowered the capital gains tax rate 35% to 21%. The bill also allowed for a one-time repatriation tax on profits of overseas subsidiaries. For individuals, the TCJA altered tax brackets, lowered tax rates, increased standard deductions, and raised family tax credits, but it also reduced itemized deductions and personal exemptions. The deduction for state and local income taxes, sales taxes, and property taxes was capped at $10,000.

While proponents of the plan suggested that the corporate tax cut would significantly boost capital spending, others argued that firms were generally flush with cash and borrowing costs were low – if they weren’t expanding in that environment, why would giving these firms more cash change their behavior? The academic literature showed that corporate tax cuts would be more likely to show through as increased dividends and share buybacks, which was definitely the case in 2018. For individuals, the impact of the TCJA was unclear. The limitation on deductions was expected to penalize those in high-tax states. As this tax season has progressed, tax refunds have been a bit smaller than a year ago (fewer returns and a lower average return). However, higher-income household tend to file later. Many of middle class households that usually receive a refund may find that they owe. However, many of those at the upper end of the income scale will find that they will get a nice refund instead. As a consequence, consumer spending at the lower end of the income scale may be a bit tighter this year. Upper income households tend to be savers, so we may not see much of a boost to spending from tax changes, but the extra after-tax income is likely to support share prices into the summer months.

Proponents of the TCJA expected the tax holiday on foreign profits to bring about $2 trillion home to the U.S. Instead, we got about a quarter of that. That’s partly because a lot of overseas profit is a tax dodge. Brad Setser, a senior fellow at the Council on Foreign Relations, asks “Why would any multinational corporation pay America’s 21% tax rate when it could pay the new ‘global minimum’ rate of 10.5% on profits shifted to tax havens, particularly when there are few restrictions on how money can be moved around a company and its foreign subsidiaries?” Foreign earnings account for nearly 40% of earnings of the S&P 500. However, “earnings” from seven low-tax nations (Netherlands, Ireland, Bermuda, Luxembourg, Switzerland, British Caribbean, and Singapore) far exceed earnings from the major economies of the world (Europe, China, etc.). Companies can (and do) issue debt backed by these overseas earnings, further reducing their U.S. tax obligations. The way to address this issue is through a coordinated international agreement, which is unlikely to happen anytime soon.