One of Donald Trump’s campaign promises was to cut taxes. The timing is looking questionable given what is happening with state finances. A report from the National Association of State Budget Officers (“NASBO”) found that half the states experienced revenue shortfalls in fiscal 2017, which began in August. The shortfalls came as sales and personal income tax growth slowed and corporate income tax declined. The number of states forced to enact mid-year budget cuts in fiscal 2016 rose to 19, which was more than any year outside of a recession since 1990. As you can see from the graph below from a recent NASBO report, the previous three recessions that began in 1990, 2001 and 2008 experienced mid-year budget cuts from 20, 16, and 13 states, respectively.
When is a Recession Coming?
Some budget analysts fear slowing sales and income tax growth is foreshadowing a recession. For example, the President-Elect of NASBO, who is also the Director of California’s Department of Finance, expressed his concerns for a recession when asked about the NASBO report. To quote him (emphasis added):
“Certainly a recession is coming sometime soon, but I think economists in all of the state offices would tell you that there’s a really hard economic forecasting angle of predicting when that’s going to happen.” – Michael Cohen, President-Elect, NASBO (December 13, 2016)
Cohen is correct: it is really hard to predict when exactly recessions begin. Nevertheless, he seems really confident in his prediction. That is probably because changes in tax revenues have historically been a reliable indicator. Consider U.S. federal tax receipts. They are comprised mainly of taxes on income and employment activity. They are also reported every month by the U.S. Department of the Treasury.
Shown in the graph above is the year-over-year growth of 12-month rolling federal tax receipts looking back 32 years. Noticeable declines in growth in federal tax receipts normally occur after recessions (grey areas) have already begun. Hence, federal tax receipts are a lagging indicator. For example, growth in federal tax receipts dropped to less than +1.0% eighteen months after the 1990 recession had already begun. Furthermore, the recessions that began in early-2001 and late-2007 were each followed by negative growth in federal tax receipts less than 12 months later.
Most recently, data ending December 2016 shows that growth in federal tax receipts has once again fallen into negative territory. Given growth in federal tax receipts is a lagging indicator, this suggests a recession is not coming soon, as Cohen predicted, but may have already arrived.
Whether or not you find federal tax receipts are a lagging indicator of recessions, please consult with an investment fiduciary before making any investment decisions.
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