On the Economy, Tax Rates & Millionaires
FORECASTS & TRENDS E-LETTER
IN THIS ISSUE:
1. Economy Showing More “Green Shoots”
2. Latest Blue Chip Economic Indicators
3. Marginal Tax Rates vs. Effective Tax Rates
4. Millionaires: Tax the Rich, But Not Us
5. Thanks For Your Feedback
Economy Showing More “Green Shoots”
We’ve seen some encouraging economic reports so far this month. The ISM manufacturing index hit a six-month high of 53.9 in December. The national unemployment rate dipped to 8.5% in December from 8.7% in November. Initial claims for state unemployment benefits fell to the lowest level in three years in the week ended on January 14 at 352,000 (of course this number is typically revised upward the following week when more data is available).
This Friday, we get our first official look at 4Q GDP, and I’m seeing some pretty optimistic pre-report estimates. Based on everything I read, there is no question that economic growth in the US improved in the 4Q. If you recall, growth in the 3Q was only 1.8%, following 1.3% in the 2Q and 0.4% in the 1Q. It’s not too hard to improve on those numbers.
Most of the pre-report estimates I’ve seen for 4Q GDP are in the 3-4% range (annual rate). Frankly, the economy didn’t feel like it grew in the 4Q by twice the rate it did in the 3Q, but consumer confidence did rebound in the last few months of last year. But we’ll know for sure on Friday morning when the Commerce Department releases its first “advance” estimate of 4Q GDP.
There are, of course, numerous forecasters that believe the 4Q GDP number will not be as high as 3-4%, but a number below 3% will likely come as a negative surprise. There are some interesting arguments about what drove growth in the economy in the 4Q as I will discuss below.
I read a LOT of different publications on the economy, but one I read faithfully every week is the Weekly Economic & Financial Commentary from the economics group at Wells Fargo. You can find it at www.realclearmarkets.com on Mondays (and it’s free). Their January 13 report offered a very interesting perspective on the economy in the 4Q:
Optimism Already Appears to be Fading
The New Year always seems to usher in an air of optimism and this year has been no exception. Better reports for the housing sector, an improving job market and generally positive news on holiday retail sales had raised hopes that the recovery was shifting into higher gear. Week two has brought in a more sober view. We have repeatedly noted our concerns about the narrow span of improvement in economic activity, the role that seasonal factors are playing in exaggerating that improvement and the lack of improvement in underlying fundaments in our analysis and outlook for 2012. This week’s data [week of Jan. 9-13] generally support that view.
The economists at Wells Fargo make a good case, I think, that the expected jump in GDP in the 4Q is probably not sustainable at least in the first half of 2012. This also helps to explain why overall retail sales were disappointing in December, up only 0.1%.
These same economists forecast US GDP growth of only 2.0% for all of 2012. They believe that the slow pace of job gains and only marginal improvement in personal income will keep consumer spending in check this year. They expect only apprx. 1.5 million jobs to be added this year, for an average of 123,000 jobs per month. If correct, that will be disappointing. They also forecast that inflation will retreat this year.
Latest Blue Chip Economic Indicators
Each month, BCEI surveys 50 well-known economists (including Wells Fargo and other large banks) for their forecasts on the economy, interest rates, unemployment, housing, etc. The BCEI average estimate of 4Q GDP was 3.1% (annual rate). As for GDP growth in 2012, the average estimate was 2.3%. By quarter, the forecast for this year was 2.0% in 1Q, 2.1% in 2Q, 2.4% in 3Q and 2.7% in 4Q.
Like the Wells Fargo economists, most surveyed by BCEI expect that consumer spending will retrench at least modestly in the first half of 2012. For all of 2012, consumer spending is only expected to rise by 2.1%. This forecast is based on the assumption of slow growth in disposable personal income and a desire on the part of households to rebuild savings. The personal savings rate fell from 5.0% last April to 3.5% in November.
The BCEI economists’ average estimate for the unemployment rate in 2012 is 8.7%, which is actually slightly above the December unemployment rate of 8.5%. If correct, this will not be good news for President Obama’s re-election chances. Time will tell.
As for 2013, the BCEI economists’ average estimate is for GDP growth of only 2.6%. Consumer spending is only expected to rise by 2.3% in 2013. Estimates for 2013 don’t deserve much credence since there are many factors that could significantly change the outlook between now and then. However, it does suggest that, absent any big changes, we are looking at another couple of years of below-trend growth (3% being the long-term trend) in the US economy. BCEI adds the following with regard to the economists’ predictions for 2013:
Of course, predictions of what 2013 will look like come with a major caveat. The threat of a major fiscal retrenchment will ratchet up at the end of 2012 when without Congressional action all of the Bush-era tax cuts will expire, large automatic cuts in defense and domestic spending will kick in, and the cut in worker’s payroll [taxes] will end if Congress ultimately enacts a full-year extension. The lame-duck Congress will have its work cut out for it following the November 6th elections.
Each month, BCEI poses a few “Special Questions” to the 50 economists it surveys. The questions vary from month to month. In its January survey, BCEI asked the economists to weigh-in on the question of whether or not Congress will approve a full-year extension of the payroll tax cut for 2012. Over 90% of the economists surveyed believe Congress will pass such an extension just ahead.
Another question asked was when do the economists believe that home prices will finally bottom out. Apprx. 75% of the economists believe that home prices will bottom out in 2012. On the question of additional quantitative easing (QE3) by the Fed this year, over 60% said they do not expect more QE by the Fed this year.
I have received a number of questions from clients and readers on this very topic, so let me try to explain how this can be. You have to understand the difference between the “marginal” tax rate and the “effective” tax rate. Under our progressive tax system, income is taxed at graduated rates. The current statutory income tax brackets range from 10% to 35%. An individual’s marginal tax rate refers to the portion of income that is taxed at the highest tax rate — not the rate for the entire amount of income earned.
[For the tax professionals and accountants in our audience, I should add that the marginal rate is not just the statutory percentage but includes all credits, hurdle, phase outs and the Alternative Minimum Tax that can cause the rate to be above or below the statutory tax rate.]
The effective tax rate, meanwhile, is the amount a taxpayer pays in taxes as a percentage of total income. Here is an example: If you file your federal tax return as a single taxpayer, had taxable income of $75,000, and paid $15,332 in federal income taxes, then your marginal rate would be 28%, but your effective rate would be 20.4%. That lower rate reflects the fact that you paid tax on portions of your income at the 10%, 15% and 25% rates, as well as the final portion at 28%.
The average effective federal tax rate for American taxpayers is 11%, according to an analysis of 2009 IRS data by the Tax Foundation, a non-profit research organization. For individuals with adjusted gross income of $50,000 or less, the average effective tax rate is less than 5%, according to the Tax Foundation. The table below illustrates the average effective tax rate paid by Americans at various income levels based on 2009 data from the IRS.
In Romney’s case, the majority of his annual income is reportedly derived from his investments that produce mainly capital gains, which are currently taxed at a flat rate of 15%. Under pressure, Romney released his 2010 tax return and estimates for 2011 today, so we’ll know more details about how much he pays in taxes, and at what rates, in the days just ahead.
Warren Buffett likes to complain that he pays a lower tax rate than his secretary, but his situation is much like Romney’s. Most of Buffett’s income is in the form of capital gains that currently enjoy the lower tax rate of 15%.
The difference in marginal rates and effective rates can be confusing because the media throws out tax rates but they rarely define which rate they’re referring to. Hopefully, this discussion helps.
Surprisingly, 71% said they believe the wealthy should pay more in taxes and give more to charity. But in the same survey, 49% said that the higher tax rate should not apply to them but only to super-rich types like Warren Buffett.
It is obvious that almost half (49%) of the millionaires surveyed don’t consider themselves wealthy. Unfortunately, the survey didn’t ask the respondents to identify just what level of wealth should trigger the higher tax rates that 71% said they favor.
At the same time, 41% said that if their tax rates were increased, they would change their investment strategy, presumably to try and avoid paying more taxes – surprise, surprise! 24% said they would reduce their commitments to charities if their taxes were increased.
What does this tell us? A lot of wealthy people like to say they’re in favor of higher taxes on the rich because it feels good and is politically correct. But when it comes down to actually paying more, almost half think the higher tax rate shouldn’t apply to them. The other thing it tells us is that a lot of millionaires honestly don’t think they’re wealthy by today’s standards.
Finally, a new Rasmussen poll taken last week found that 47% of likely voters would support a presidential candidate who promises to raise taxes only on the rich, while only 36% said they would support a candidate who opposes all tax increases. Another 18% weren’t sure. President Obama’s message of higher taxes on the rich is resonating, sadly. Unfortunately, Obama’s definition of “rich” is families making over $250,000 a year.
Almost all expressed their appreciation for the work I do in writing these letters week in and week out, which is always encouraging. Several had specific questions such as the difference in marginal tax rates versus effective tax rates, which I discussed today.
If you have a topic you’d like me to address, let me know. I can’t promise I’ll write about it, but I welcome your suggestions – the more, the better. Often times when we get questions from readers, we send them a link to a specific article that addresses that issue or question.
Thanks again to all of you who took the time to respond!
Gary D. Halbert
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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.