Conclusion: The consumer’s State & municipal government tax burden is headed north on a nationwide basis starting in FY12. Additionally, we are of the view that the “G” component of US GDP (~20%) will continue to weigh on the economy over the intermediate-term TREND and we detail why in the report below.
As outlined in our recent presentation on US interest rates, we are of the view that the “G” component of US GDP (~20%) will continue to weigh on the economy over the intermediate-term TREND. While we certainly do not support the tired Keynesian Dogma of textbook “countercyclical government spending”, we do agree that fiscal retrenchment throughout the economy will auger bearishly for near-to-intermediate term economic growth. On a long-term basis, however, we welcome a much needed dose of fiscal austerity and would view that as positive for the confidence that ultimately drives consumer spending and corporate investment alike.
From a Federal perspective, we continue to believe that the negotiations centered around the Debt Ceiling Debate are likely to result in reduced levels of spending in the FY12 budget, as well as some groundwork laid for entitlement reform – though the tough decisions will likely continue to get punted to future Congresses. That said, however, any austerity at the Federal level is a sharp reversal from what certainly looks and feels like permanently enacted stimulus spending. Refer to Daryl Jones’ 4/20 Early Look titled, “The Case of the Missing Stimulus” for more details. This is one of many potential positive catalysts for our long DXY position in the Virtual Portfolio.
From a State & Municipal perspective – which is the real focus of this note – we continue to highlight their fiscal stress as a headwind to 2H11 and 1H12 GDP growth. According to the National Association of State Budget Officers Spring 2011 Fiscal Survey of the States report, an aggregate $75.1B budget gap must be closed with the enactment of FY12 budgets (starting July 1st in all but four States). Furthermore, the $75.1B is likely to be revised higher in coming weeks, due to additional States’ completions of official forecasts (17 States remaining). That $75.1B-plus number is on top of a cumulative $12.1B in mid-year budget gaps from the FY11 budget that must be closed by June 30th. All told, assuming a constant budget gap-to-State ratio for the 17 States which have yet to report and the additional $12.1B in mid-year FY11 deficits, a budget gap of roughly $126B must be rectified via legislation in the coming weeks (with the exception of Vermont, all States have balanced budget statutes).
Perhaps the most noteworthy way in which States are prescribing to close their deficits is tax and fee increases. On a net basis, States are proposing tax and fee increases to the tune of $13.8B – a YoY gain of +122.6% vs. FY11’s $6.2B tax hike (-74% YoY). From a breadth perspective, the tax and fee increases are more concentrated in FY12 budget proposals (12 States) vs. last year’s 24 States. Still, the aggregate sum of taxation on a national level is what matters to the overall economy and, on both a nominal and sequential basis, State tax and fee hikes are an additional headwind to the economy over the intermediate-term TREND. Some States are even hiking taxes in arrears; CT, which just increased taxes and fees by a record $2.6B is applying the changes on a retroactive basis to January 1, 2011.
Below we detail the proposed FY12 tax and fee hikes on a national basis per the aforementioned NASBO report:
- SALES TAXES: Seven States proposed increases while three States proposed decreases for a net gain of $6.1B;
- PERSONAL INCOME TAXES: Six States proposed increases while seven States proposed decreases for a net gain of $5.9B;
- OTHER (including alcohol, tobacco, motor fuel, fees, etc.): 18 States proposed increases while eight States proposed decreases for a net gain of $2.4B.
As the chart below highlights, sharp accelerations in proposed State level tax and fee increases have been reasonably shown to lead 100bps-plus slow-downs in the rate of Real GDP growth by 6-12 months on average (likely due to the timing of State fiscal years, which typically begin six months prior to the start of the corresponding calendar year).
One positive callout amid this plethora of rising taxes is the net decrease of $537.2 million from corporate income taxes. To the extent a -1.2% reduction in aggregate State corporate income taxes stimulates job growth rather than mere earnings preservation in a slowing economy remains to be seen. Still, it’s a positive development nonetheless.
From a municipal government perspective, the most notable change to taxes and fees come in the form of property tax hikes. Simply put, as property appraisal values continue to decline on their typical 2-3 year lag to national real estate prices, city and county financiers have taken to gradually increasing property tax rates to offset any declines from this important source of revenue (~26%). As to be expected, property tax appeals have risen sharply on a national level. From our gathering of recent anecdotes, municipalities from Westchester County (NY), to Maui County (HI), to Hernando County (FL) are seeing record levels of property tax appeals that amount to doubling, tripling, and even quintupling of pre-crisis levels. The sheer volume of new cases is creating backlogs across the nation that may eventually amount to incremental hundreds of millions added in arrears to municipal budget deficits – at a time when funding from both the Federal and State level is set to decline dramatically. Still local government officials carry on with their “accounting tricks” for lack of a better solution:
“New Rochelle has seen its tax roll drop by 2 percent or 3 percent a year, so just to get the same revenue, you need to raise tax rates by that much.”
-Howard Rattner, New Rochelle Finance Commissioner
The net result of these gimmicks means homeowners get plugged with higher tax rates amid falling home prices. While payments on a net basis are likely to remain sticky, the psychological effect of higher property tax rates in an environment of ever-falling appraisal values is not one that is bullish for consumer confidence on a national level. Neither is a $13.8B increase in the consumer’s State tax burden. To the extent State and municipal tax and fee increases are offset by Federal tax cuts into and out of the Debt Ceiling Debate and FY12 Budget Debate remains to be seen – though likely at least to some degree. Still, any resulting spending cuts are likely to be an additional drag on the economy in the near-to-intermediate term that is likely to be eventually offset by higher levels of consumption and investment over the intermediate-to-long term due to [anticipated] tax cuts.