Sunday, March 29, 2020

What Happens as State and Local Tax Revenues Crater?

We can anticipate a federal bailout of pension funds and one-time aid to state and local governments, but bailouts won't repair the eroding foundations of tax revenues.
As we all know, the federal government can "print" money but state, county and city governments cannot. The Treasury can sell bonds to fund deficit spending, and the Federal Reserve can create currency out of thin air to buy the bonds, so federal spending can increase even as tax revenues crash.
State, county and city governments do not have this printing press. Yes, states and counties can sell municipal bonds for infrastructure projects, but they can't sell bonds to support General Fund (i.e. everyday government services) expenditures.
As a result, massive declines in State, county and local tax revenues are already baked in as sales and payroll taxes drop and capital gains taxes--an essential source of revenues for many states--are set to collapse along with the stock market.
Longer term, the other primary source of tax revenues--property taxes--will fall off a cliff as the commercial real estate bubble and Housing Bubble #2 implode later this year. Lower sales, lower employment and lower profits all undermine the fundamentals of real estate, and the institutionalization of remote work and education will gut demand for commercial space.
Real estate transactions are also sources of transfer taxes and capital gains, and as values plummet so will transfer taxes and capital gains.
Every locale has a different mix of tax revenues, but since all sources will fall sooner or later, no state or local government will escape the decline in revenues. Sales (excise) and payroll tax revenues will fall first, and capital gains will vanish as stock market losses replace gains.
In states like California that depend heavily on capital gains taxes, the holes being blown in budgets will be catastrophic. Roughly 10% of all General Fund revenues in California flow from capital gains--over $15 billion in the previous fiscal year. As noted in the California State Revenue Estimate 2019-2020:
"The amount of capital gains revenue in the General Fund can vary greatly from year to year. For instance, in 2007, capital gains contributed $10.9 billion to the General Fund. By 2009, the contribution from capital gains had dropped to $2.3 billion. For 2018, capital gains are forecast to contribute $15.7 billion to General Fund revenue--the highest amount ever."
Were this to drop to previous recession-era lows, that would open a $13 billion hole in tax revenues, completely erasing the state's $8 billion "rainy day fund" and leaving a $5 billion deficit--a sum that will only increase as sales and payroll taxes decline.
Once Silicon Valley Unicorns, Big Tech and zombie corporations start laying off highly paid staff, income tax revenues will crater as well. As the California State Revenue Estimate 2019-2020 explains:
"The highest-income Californians pay a large share of the state's personal income tax. For the 2016 tax year, the top 1 percent of income earners paid just under 46 percent of personal income taxes. This percentage has been greater than 40 percent in 12 of the past 13 years. Consequently, changes in the income of a relatively small group of taxpayers can have a significant impact on state revenues."
Many states and counties are increasingly dependent on a dominant revenue source which may well prove to be an Achilles Heel. California has increasingly come to depend on income taxes from high earners (who also garner most of the capital gains as well):
"In 1950-51, sales tax revenue made up over 50 percent of General Fund revenues while personal income tax revenue made up just more than 11 percent. That relationship has changed dramatically over time, and, for 2019-20, personal income tax makes up 68.8 percent of all General Fund revenues."
A steep decline in tax revenues isn't the end of the pain for local government. Public-sector pension funds heavily invested in stocks are absorbing shattering losses that will have to be compensated by higher contributions by cash-strapped taxpayers. If bond yields rise despite central bank interventions, bond holdings could crash along with stocks.
We can anticipate a federal bailout of pension funds and one-time aid to state and local governments, but bailouts won't repair the eroding foundations of tax revenues. Sales: down. Income: down. Capital gains: down. Vehicle sales: down. Fuel taxes: down. Property taxes: down, once bubble valuations crash to earth.
Cash-strapped taxpayers, many of whom may have lost their jobs, will be in no mood to absorb enormous tax increases to fund insiders, cronies and vested interests.
The gravy train of state and local government spending has just been derailed. The declines in tax revenues will be too steep and too enduring to support the magical-thinking hope that a V-shaped recovery will make all the blown budgets whole next quarter, much less next year.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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Saturday, March 28, 2020

The New (Forced) Frugality

There are only two ways to survive a decline in income and net worth: slash expenses or default on debt.
In post-World War II America, the cultural zeitgeist viewed frugality as a choice: permanent economic growth and federal anti-poverty programs steadily reduced the number of people in deep economic hardship (i.e. forced frugality) and raised the living standards of those in hardship to the point that the majority of households could choose to be frugal or live large by borrowing money to enable additional spending. Either way, rising income and net worth would raise all ships, frugal and free-spending alike.
For everyone above the bottom 20%, frugality was viewed as a sliding scale of choice: if you couldn't increase your income fast enough, then borrow whatever money you needed. If you chose to be frugal, in moderation (i.e. clipping coupons and shopping for the cheapest airline seats, etc.) this was viewed as admirable fiscal prudence; if pushed beyond moderation then it was dismissed as counter to the American spirit of everlasting expansion: tightwad is not an endearment.
Thus none of us immoderately frugal folks ever fit in. Our frugality raised eyebrows and drew derogatory exhortations from indebted free-spenders to "get out there and live a little," i.e. blow hard-earned money on aspirational gewgaws or status-enhancing fripperies, including the oh-so-precious "experiences" that have now replaced gauche physical markers of status-climbing.
We are now entering a new era of forced frugality in which incomes and net worth stagnate or decline while the cost of living rises and borrowing is no longer frictionless.
To say that these changes will shock the system is putting it mildly. Here's the key dynamic in forced frugality: income can drop precipitously without any ratcheting to slow the decline, but costs only ratchet higher, or decline by nearly imperceptible degrees; that is, costs are "sticky" and refuse to slide down as easily as income.
The second key dynamic in forced frugality is the tightening of lending and the rising cost of borrowed money. When lenders could assume that almost every household's income would increase as a byproduct of ceaseless economic expansion, and assets such as stocks, bonds and houses would always increase in value (any spots of bother are temporary), then the odds of a nasty default (in which the borrower stiffs the lender--no monthly payments to you, Bucko)--were low.
But once incomes and asset valuations are more likely to fall than rise, the door to lending slams shut. Why would lenders extend loans to households and enterprises that are practically guaranteed to default? Any lender that self-destructive would soon be stripped of their capital and solvency.
The general assumption is that since central banks are buying bonds, interest rates for borrowers can only go down. This assumption is misguided. The base assumption of all lenders is that a very thin layer of borrowers will default. Once this layer thickens, it makes no sense to lend to everyone who can fog a mirror.
Unwary lenders are about to learn a very painful lesson about the creditworthiness of supposedly solvent middle-class households: since income isn't "sticky," households that had high credit scores for years can quite suddenly default on their loans once their incomes plummet.
As for the borrower's assets, those too can plummet in value, leaving the lender with zero collateral or an asset for which there is no buyer, regardless of the appraised value.
The income/assets slope is greased while the cost slope is on a resistant ratchet. Income can slide down effortlessly while costs stubbornly refuse to fall.
The net result of this dynamic is forced frugality. For the first time in decades, households and enterprises cannot count on a resumption of growth in a few months and higher incomes and asset valuations.
To the dismay of living-large-on-debt households and enterprises, the only way to get more than you have now will be to save, save, save cash. Earning more from one's labor will be difficult, as will reaping easy speculative gains from simply owning assets.
The debt-free frugal may be forgiven for indulging in a bit of schadenfreude toward those who scorned frugality in favor of living large in the moment. Now who's living large? Not the extremely frugal, because squandering money gives them no pleasure, and they prefer the anti-status "status" of old cars and trucks, tools that have lasted decades and assets that look like everyone else's except they're debt-free.
As for income--those who control and invest their own capital and labor, the class I've long called mobile creatives--will have far more opportunities than those chained to the monoculture plantations of corporate cartels and government agencies squeezed by collapsing tax revenues.
A great many people who reckoned moderate frugality was more than enough will discover it no longer suffices. A great many other people who reckoned they were rich enough to spurn frugality will discover their income no longer covers their expenses and so expenses will have to be slashed and burned to the ground.
And many frugal people who did the best they could with limited income will find that even extreme frugality can't fix a decline in income.
An economy-wide reckoning of what's essential is just starting. Netflix subscription? Gym membership? Fast food takeout a couple times a week? No, no and no. A thousand no's as there are only two ways to survive a decline in income and net worth: slash expenses or default on debt. Both are toxic to "growth" in spending and debt.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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Wednesday, March 25, 2020

The Pandemic Is Accelerating the Breakdown That Began a Decade Ago

The feedback loop has reversed: by saving more, people will spend, borrow and speculate less, draining the fuel from any broadbased expansion.
In eras of confidence and certainty, people save less and spend more freely. When we're confident that good times are not only here but will continue, we not only spend more freely, we're more inclined to borrow money and speculate on the shimmering promises of more good times ahead.
In eras of uncertainty, people save more and spend, borrow and speculate less. There is an obvious feedback loop here: if people feel confident about their future prospects and have a measure of certainty about the general economic trend, they spend more, borrow more and speculate more, all of which feed the expansive mood that then encourages further spending, borrowing and speculating.
If their confidence collapses and the future is deeply uncertain, people save more as a hedge against bad things happening in the economy that could trigger hardships in their own household.
With this in mind, it's interesting to look at a long-term chart of the U.S. savings rate, courtesy of the St. Louis Federal Reserve database (FRED). It's easy to discern the waxing and waning of confidence / certainty in the decline or expansion of savings.
The broadbased prosperity of the 1960s is reflected in the high savings rate as cheap oil and real-world growth (as opposed to financial trickery and speculation) fattened paychecks while real-world inflation (cost of living) remained low.
The uncertainties of stagflation--oil shocks, recessions and soaring inflation and interest rates-- pushed savings higher in the early 1970s. As purchasing power and speculative gains fell, so did the savings rate as households struggled to keep up with soaring costs of living.
Once inflation and speculative excess were wrung out, the stage was set for a 25-year expansion of "good times" powered by the financialization of the entire economy, the rise of high tech and the first stages of de-industrialization and offshoring, a.k.a. globalization.
Note that the savings rate popped higher after the 1991 oil-shock / Desert Storm recession and again after the dot-com bubble burst in 2000-02.
But the trend to save less and spend/speculate more continued until the the housing bubble burst, triggering the Global Financial Meltdown of 2008-09. When the dot-com bubble burst, the effects were largely confined to the tech sector and those who had speculated in the frenzy. But the housing bubble bursting had far wider consequences, as housing is the bedrock of household wealth and mortgages are the largest category of household debt.
The primary trick of financialization is to turn previously low-risk assets such as home mortgages into high-risk financial instruments that can be traded globally as "low-risk" assets. This fiction--greased by rampant fraud and institutionalized misrepresentation of risk--nearly brought down the global financial system when it finally unraveled.
This globalization of financialization went hand in glove with the rapid expansion of offshoring and the hollowing out of real-world economies as the purchasing power of labor (wages) stagnated for all but the top tiers (top 5% and to a lesser degree, the top 10%) of technocrats, managers and entrepreneurs who rode the wave of globalization and technology.
To save the financial system from a well-earned collapse, central banks pushed monetary policies to unprecedented extremes, lowering interest rates and flooding the system with liquidity / stimulus. These extraordinary monetary policies boosted assets while leaving the real-world economy in decline as globalization stripmined local economies that could not compete with global corporations feasting on low interest rates, a steady decline in quality and quantity designed to increase profits and cheap overseas labor.
Despite the thin gloss of "growth" this hyper-financialization generated, the stagnation of wages and real-world economy are reflected in the savings rate which has been steadily rising since 2009. The erosion of the real-world economy and the purchasing power of wages has sapped confidence in future prospects and ushered in an era of rising uncertainty.
The economic-financial fallout from the Covid-19 pandemic is accelerating the loss of confidence and the rise of uncertainty that has been trending higher for over a decade.
The feedback loop has reversed: by saving more, people will spend, borrow and speculate less, draining the fuel from any broadbased expansion. This is one reason why monetary policy extremes won't revive growth, real or fictitious: the uncertainty that was launched in 2009 is only deepening.
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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Monday, March 23, 2020

Helicopter Money: Short-Term Relief Won't Cure our Financial Disease

The collateral supporting the global mountain of debt is crumbling as speculative bubbles deflate.
A great many freebies are being tossed in the Helicopter Money basket. That households experiencing declines in income need immediate support is obvious, as is the need to throw credit lifelines to small businesses. But beyond those essentials, the open-ended nature of Helicopter Money has unleashed a frenzy of political favors and giveaways that have little to do with helping households and everything to do with rewarding favored cronies, cartels and interest groups.
As Gordon Long and I explain, the short-term "pain relief" of Helicopter Money won't cure the economy's financial disease; rather, it will act as a catalyst for longer-term disruption and decline.
None of the giveaways being discussed address the core causes of our systemic financial disease:
-- Erosion of real-world collateral supporting the ever-growing mountains of debt and leverage
-- Diminishing returns on monetary stimulus (Federal Reserve financial cocaine no longer generates euphoria)
-- Domino-like disruption of global supply chains and global demand
-- Stagnating purchasing power of labor
-- The use of debt to keep up with the soaring costs of essentials (rent, healthcare. childcare) and aspirational goods (iPhones) and services (vacations)
-- Repricing of risk and risk assets
The stability of the entire system is increasingly fragile and brittle. The abuse of money-printing--creating currency to benefit bloated, inefficient, parasitic, predatory institutions, cartels and monopolies--is further eroding already-decaying confidence in monetary and fiscal authorities and policies.
The collateral supporting the global mountain of debt is crumbling as speculative bubbles deflate. What happens to margin debt when the $300 stock falls to $100? What happens to the $1 million mortgage when the decaying bungalow's value falls from $1.2 million to $400,000?
The inevitable result of creating currency is excess of the creation of goods and services is a decline in purchasing power which we experience as inflation / shrinkflation (getting lower quality and less quantity even though the price has remained the same).
This loss of putchasing power has been masked by bogus statistical tricks and shrinkflation, but as the Helicopter Money trillions flood through the economy and global supply chain disruptions cause prices to rise, the usual bag of tricks will no longer be enough to hide the higher costs and declining purchasing power.
Then there's the psychological impact of the reverse wealth effect as households and enterprises see their net worth and income dropping. The confident euphoria required to borrow and spend freely has evaporated and will not be returning, regardless of how much currency is created and distributed.
Gordon and I discuss these topics in this 37-minute video:
If you missed our three-part series:
Money and Work Unchained $6.95 (Kindle), $15 (print) Read the first section for free (PDF).


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