In June, 77% of the states in our survey met or exceeded their forecasted withheld tax collections, up from 72% in May, and 86% reported growth over the year, up from May’s 82%. The average overthe- year growth rate was 3.3% in June, basically flat with May’s 3%, and the margin over budget held at 0.1% (all weighted by state population).

A number of our contacts remarked on how noisy their data have been recently, and underneath all the noise the three-month moving average of our withholding diffusion index has slipped back to where it was in November. A few contacts were encouraged by June receipts, suggesting that they may be re-accelerating after a disappointing April and May, while a number of others noted the slowdown reflected in our index’s moving average. Again this month, there was no clear regional pattern, but the housing bust states continue to slow improvement, and states with heavy energy extraction continue to report strong tax receipts.

The anecdotal envelope, please

We are hearing from many editors, photographers, publishers and other “pretty well paid freelancers,” who have suffered through extended periods with no work at all in recent years, that they are currently getting temporary or parttime jobs. Not great, but an improvement.

On the other hand, yesterday’s Wall Street Journal ran an interview with the CEO of a consumer products manufacturer in Missouri. Business conditions last year led him to believe that he’d be hiring hundreds of new workers by now, but the recent slowdown, working in concert with spiking scrap metal prices (they meltdown their own metal), has caused him to, instead, lengthen work weeks and “see how things go. Until we start seeing more people confident about the ability to get work, I’m holding back.”

And one of us sat next to a regional manager for a large clothing company on a westbound train last month. He lamented the fact that he lost control of compensation for the employees he hires and trains when his outfit was bought out some years ago. “I’ve got dedicated workers who have been making minimum wage for 5 years without a raise, a bonus, even an acknowledgement, which makes me really uncomfortable.” Sobering thought that his employees have worked for minimum wage for 5 years and retain the adjective "dedicated. "

The fiscal picture

Just how dire is the U.S. budget situation? To listen to some of the rhetoric, you’d think we’re the next Greece. But do the more or less official projections from the Congressional Budget Office (CBO) justify the anxiety?

As we’ve pointed out before, deficits over the last couple of years are mainly a product of the Great Recession—a collapse in revenues combined with an increase in spending (both the normal countercyclical spending on unemployment insurance and the extraordinary spending on TARP and ARRA). The cyclical composition is already starting to wane, and should continue to do so over the next year or two.

Graphed at the top of p. 3 are the CBO’s projections for federal receipts and outlays for the next decade. Two versions are presented—a baseline scenario, which would prevail if Congress did nothing (a prospect that might sound mighty tempting), and an alternative, which would prevail if certain things that Congress may well do come to pass (like extending the tax cuts or rescinding the planned cuts in Medicare payments to doctors).

Note that in the baseline scenario, outlays fall back for the next several years, and then start rising after 2015. But receipts also rise, as the tax cuts expire (and the economy recovers). In the alternative scenario, outlays rise more dramatically after 2015 (thanks mainly to higher Medicare spending and rising debt service costs) and revenues lag (because the tax cuts are extended). In the baseline scenario, the deficit stabilizes at around 3% of GDP; in the alternative, they it barely falls below 6% before rising toward 8%.

So, the revenue choices are pretty clear: extend the tax cuts or not. Although many analysts want to extend them, which would keep revenues at around 18% of GDP, allowing them to expire would bring the revenue share up to about 20%, which is where they were in the late 1990s, which weren’t what you’d call bad times.

But what exactly is driving spending? That’s the question addressed in the graphs at the bottom of p. 3. In both cases, the driving factor is health spending, with some assistance from interest. Social Security is a minor factor, and the rest of the budget contracts significantly. The major difference between the baseline and alternative scenarios is that increases in health and debt service are greater; the rest of the budget contributes little or nothing.

It’s tempting to blame the rise in health spending on profligacy, but as the graph at the top of p. 4 shows, reality is more complicated: programs like Medicare and Medicaid are not becoming more generous in the breadth of their coverage. The major reasons for the rise in spending are the aging of the population and relentless medical inflation. Cutting Medicare and Medicaid would merely shift the locus of spending from Washington to individual pockets. For example, the CBO estimates that Rep. Paul Ryan’s plan to cap Medicare spending would double consumers’ out-of-pocket spending. It wouldn’t reduce the flow of dollars spent on health care. Somehow, we have to get a hold on medical inflation and fund the health needs of an aging population; these are more profound questions than can be solved in a debt ceiling showdown.

The major drivers of spending are what are known in budget jargon as “mandatory”—they’re on autopilot every year, unless Congress makes a major decision to change them. A smaller portion of the budget—about 40%—is “discretionary,” meaning that Congress has to appropriate the funds every year. These are much harder to project, so the CBO goes into little detail about them. The biggest discretionary item is military spending. The CBO offers several scenarios for military spending, two of which are graphed on the bottom of p. 4. Merely reducing the number of troops deployed in Iraq and Afghanistan would bring spending down by 1.7% of GDP—and the projected 2021 deficit in the baseline scenario down to a trivial 1.4%. That option doesn’t look to be part of the current budget negotiations, however.

The remainder of the budget is domestic discretionary spending, less than one-fifth the total. Out of that comes spending on education, infrastructure, R&D, and the environment. Though the costs are relatively small and the payoffs often quite large, this is a prime target for budget cutting.

The CBO also does far longer-term projections, going out about 75 years. These can get scarily disastrous, with debt/GDP ratios tripling to over 200% in 2038 in the alternative scenario. Fans of deficit hysteria prefer these projections, but we’d take them with a grain of salt. Projecting anything that far out seems a little loopy from the start, as CBO officials have noted in Q&As. But the economic assumptions behind them are also somewhat strange: trend GDP growth of around 2.0% (which, if true, would be a major departure from U.S. historical experience), and very high interest rates—a real rate of 3.0% on 10-year Treasuries (vs. a long-term average of 2.3% since 1919), despite low inflation and slow growth.

In any case, it seems way premature to make dramatic cuts in spending on the basis of projections of what might happen 25 years from now. If the tax cuts are allowed to expire, the fiscal situation is quite manageable for at least the next decade.

Skew

Drastic fiscal action could well exacerbate the skew in the distribution of income that’s developed over the last several decades. As the graph on the top of p. 5 shows, the ratio of the income of the top 1% to that of the bottom 90% is only slightly off an eighty-year high. (The data, from Thomas Piketty and Emmanuel Saez, only go through 2008. It’s likely that the recent highs are being revisited now.)

There are many explanations for this development, but one is that an enormous gap between productivity and pay has opened up, much to the advantage of profits. As the graph on the bottom of p. 5 shows, productivity is up about 150% since 1964, but compensation (including fringe benefits) is up only about 80%, and direct pay, only about 15%. The trend has been underway since the early 1970s, but accelerated in the early 1980s.

The national income accounts offer another perspective on this phenomenon. As the graph above shows, seven quarters into the recovery, profits are up 54%, and employee compensation, not quite 5%. (That’s total compensation, not average wages.) The ratio is about 12-to-1—four times the historical average. In the previous expansion, the ratio was 10-to-1. In no previous recovery did it exceed 4-to-1.

Whatever you think of the justice of this arrangement, it doesn’t seem either economically or politically sustainable. Would-be budget cutters should think carefully about the distributional effects of what they’re contemplating.

Friday’s numbers

We think the weakness in the May employment report was overdone, and that we’ll have some rebound in June. But probably not all that vigorous a rebound. Note the rolling over in the Conference Board’s Employment Trends Index, graphed on p. 2; the slowing momentum has now given way to an actual decline in the index over the last couple of months. This portends a slowdown in job growth over the next few months.

With that in mind, and with the stickiness in initial claims and the deterioration in some of the private surveys, we suspect that hiring has slowed. We’re looking for private sector gains of 107,000 jobs in June, public sector losses of 20,000, netting to a headline of 87,000 jobs. (In May, violent storms and flooding may have depressed payrolls, but flooding, real and threatened, continued into the June survey week along the Missouri and Mississippi Rivers, and we suspect hiring may not have rebounded by the time the BLS collected their data for the month.)

Unless a substantial number of workers rejoin the labor force, we forecast a 0.1 point decline in the unemployment rate (especially if the household survey catches the modest improvement in the situations of the self-employed), an unchanged workweek, and a 0.1% increase in average hourly earnings, on the heels of May’s more robust gain. If we get an upside headline surprise, we suggest it be interpreted as messy data and not as a true change in trajectory.

 

 

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