INSIGHTS: TAX REFORM HAS ALREADY RECOUPED $400bn OF THE COST
By Guest Columnist Dan Clifton:
Director and Head of Public Policy Research, Strategas Research Partners
Recently, the Congressional Budget Office (CBO) released its official Budget and Economic Outlook for fiscal years 2018-2028. CBO’s update was highly anticipated as the new estimates incorporated the fiscal impact of the recently passed Tax Cut and Jobs Act (TCJA). The press quickly jumped on the increasing deficit numbers with the federal budget deficit expected to hit $1 trillion in 2020, two years faster than the previous estimates were forecasting. Recently passed tax cuts were quick to blame. But a closer read of the CBO document shows a very significant upgrade for US economic growth and by extension the feedback effect on tax revenues.
The report showed that the tax cut has already recouped $400bn of the expected “cost” of the tax cut, a 28 percent reduction from last December. And this was just the first installment. More reductions in the cost will be made once the tax cut unleashes investment in the US economy.
The Tax Cut and Jobs Act provided significant tax relief to both consumers and businesses. Individual and small business taxpayers will receive $120bn of net tax cuts through lower income tax rates, an increase in the per child tax credit, and a small businesses tax rate of 29 percent tax rate.
Companies will receive $80bn in net tax cuts with the corporate tax rate slashed from 35 to 21 percent, 100 percent expensing of capital equipment purchases, US companies being able to repatriate their future profits back to the US tax free for the first time.
In response to the tax changes, the CBO significantly upgraded its outlook for the US economic growth by 50 percent. More specifically, the CBO report upgraded their 2018 and 2019 real GDP forecast from 2.2 and 1.9 percent to 3.3 and 2.9 percent respectively. This 50 percent change in expectations for economic growth is far greater than a rounding error. CBO upgraded nominal GDP by a cumulative $2.9 trillion and believe 14.5 million more jobs will be created over the next five years than forecasted last June.
Higher levels of growth, jobs, and investment translates into more tax revenues than initially forecasted. When Congress debated TCJA last year, the Joint Committee on Taxation (JCT) estimated the government would lose $1.4 trillion of tax revenue over the next ten years. At that time, JCT and CBO were anticipating $43 trillion of tax revenue. Passage of $1.4 trillion TCJA revised down expected tax revenues to $41.6 trillion over the next ten years.
The CBO report shows that tax revenues are now expected to be around $42 trillion over the next ten years, a $400bn upgrade from the December estimates. Roughly 28 percent of the so called “cost” of the tax cut has been recoupled. We believe this is the just the first installment and further tax revenue upgrades will be made later this year and early next year as investment, job creation, and profits increase more than is currently forecasted.
Congress needs to focus on spending discipline to keep deficits down in the future.
ON THE ECONOMY: IT’S A GAS
By John Dunham:
Managing Partner, John Dunham & Associates
It’s a gas – followed by a series of burps and grunts, was a song written by Norm Blagman and Sam Bobrick and released as a plastic flexi-disc in the 1966 Worst of Mad #9 issue of Mad Magazine.
In 1966, the price of oil was $2.97 per barrel, which is equal to about $23.31 today. With West Texas Intermediate Crude (WTI) oil now sitting at around $68.00, one can easily see that oil prices have risen by nearly three-times the rate of inflation. Rapidly rising energy costs have had many impacts on the economy, some good and some quite bad. One thing that rising energy prices have done is to increase productivity. Businesses and households have learned to do more with less. I have a house that was built in 1968 and it has virtually no insulation. Today, houses are nearly air tight. Furnaces are more efficient as are stoves, refrigerators, air conditioners, you name it. My first car made 9 miles to the gallon – no seriously, 9 miles to the gallon. Today I drive a diesel truck that makes 25 miles to the gallon, and it is not uncommon to see automobiles that make 50 miles to the gallon of gasoline.
Doing more with less is how an economy grows, and productivity increases like these are a long-term benefit of high oil prices. On the supply side drilling and well completion processes have helped open up vast new oil fields, pipelines and infrastructure waste far less energy than they did in the past, and new energy technologies like fuel cells and solar panels have mitigated the use of fossil fuels in many cases.
On the negative side, huge amounts of capital that could have been spent on other more important uses have been languished on higher priced petroleum. Who knows how many more medical cures could have been found, or new manufacturing technologies developed had fuel been less expensive. Maybe we would have colonies on Mars by now, or maybe cancer would be a thing of the past. One never knows what might have been.
All that said, we have been going through a period of fairly stable prices for oil over the past few years. After having plummeted by nearly 63 percent between the middle of 2014 and early-2016, oil prices stabilized in the $50 per barrel range (again WTI) for about two years. However, starting in late 2017, prices began to spike and are up by about 33 percent in a few short months. While still well below earlier peaks, this seems to be a big change – roughly $19 per barrel. What is happening?
It seems that there are basically four things in play: A falling dollar, short-term domestic supply disruptions, increased demand, and a change in the geo-political climate. Let’s start with the dollar. Since September of last year, the dollar has lost about one percent of its value. Considering oil is priced in dollars and is generally a fungible commodity, the price of oil would have risen from about $47.30 at the beginning of September 2017, to $47.70 today. So this accounts for just $0.37 of the $19.00 jump.
There have been disruptions in the US supply of oil due to inclement weather, hurricanes, and some pipeline developments. The difference in the increase between US prices (WTI) and world prices (Brent) should account for that. Looking at the data, during the period from September of last year to now, Brent prices have risen at a 6 percent slower rate than US prices. Accounting for this would mean that prices in the US would be just over $50.00 about $2.70 of the $19.00.
Energy demand has grown by about 4 percent over the past year in the US, while production has risen by 3.6 percent an 11 percent difference. Energy tends to have a low elasticity so the change in price from this increase in demand should be about 3.9 percent, or in this case $1.82. Let’s add in general inflation of about $0.52 per barrel, and these factors bring the price of oil from $47.30 per barrel at the beginning of September 2017 to $52.72 today. That is a big difference ($13.50) from the most recent spot price of $66.23. This brings us to geo-political causes.
In recent months, the 13 countries that make up the OPEC cartel have reduced production by just over two percent. While this would impact prices, non-OPEC producers are making up for this – but not as fast as world demand has grown. Based on OPEC statistics, demand is growing about 38 percent faster than supply (accounting for the recent OPEC production caps) suggesting that prices should rise by $6.29 per barrel.
Still all of this together leads to a price increase from $47.30 to just about $59 per barrel. This places the price based on market conditions well within both our forecast range and that of the US Energy Information Agency. So why the additional $7.00, and why are so many analysts suggesting that oil could reach $80 per barrel?
Well, that is due to our nemesis in economic forecasting – exogenous factors. Oil is traded on world markets and the price is set by commodity traders all around the world. When they get skittish about the potential for supply disruptions, short term prices can rise quickly. This seems to be what is happening. There have been a number of geo-political events in recent weeks that all could impact the supply of oil including: The collapse of the Venezuelan economy, strife between Russia and the West, US attacks on Syria, and the potential for conflict with Iran were the United States to disengage from the current multi-state agreements with that regime. Add to that an extraordinarily cold winter (particularly in locations where oil is traded) and that send speculation into a frenzy. Enough of a frenzy to bring oil prices up on short-term contracts.
We continue to think that (barring any wars or actual supply disruptions) oil prices will fall back to a band averaging around $60 per barrel even if the OPEC production agreements hold. If these were to soften then oil prices could trend back toward the $55 range. All of the burping and grunting of market traders can never change the market itself – at least over the long-term. There is nothing Mad about that.
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