The first batch of post-Katrina data show that the economy was more resilient than expected during September with core retail sales and high-tech production expanding at robust growth rates. Broad-based increases in tax receipts, which are rising at 2.4 times the rate of nominal GDP growth, also are indicative of an economy that is running on all cylinders.
During September, core retail sales (which include the effects of hurricanes Katrina and Rita) advanced 0.6 percent month-on-month and are up 6.6 percent year-over-year. September also showed surprising strength in general merchandise (up 0.9%), building materials (up 1%), electronics (up 0.8%), and furniture (up 1.2%). This positive showing is the result of strong household balance sheets and robust income-growth trends, and flies in the face of the claim that higher energy prices are dragging the consumer down.
Energy now comprises 5.4 percent of disposable income compared to more than 8 percent during the early 1980s. Relative to household net worth, the broadest measure of the consumer’s balance sheet, energy is one-third as relevant today as it was twenty-five years ago. Strong financial and income trends have offset the energy spike.
And despite Katrina-related weakness in the headline production figures for September, high-tech production accelerated — a sign that the entrepreneurial economy remains strong. The industrial production report for September showed an overall 1.3 percent month-on-month decline. However, according to the Federal Reserve, storm-related production declines held down industrial activity nearly 1.7 percentage points during September while an aircraft industry strike reduced industrial output by almost 0.5 percentage points. During August, storm-related weakness reduced industrial production by nearly 0.4 percentage points. But excluding the impact of the storms, industrial production rose at a 9 percent annualized rate during August and September. High-tech production, meanwhile, rose at a blistering 3.7 percent rate during September and is up 24.6 percent year over year, the fastest in more than four years.
News on the tax-and-spending side is just as encouraging. Despite all of the hyperventilation and hand wringing over deficit spending in Washington, particularly as Congress looks to pour in the neighborhood of $150 billion into Gulf Coast reconstruction, tax receipt data for the just-completed fiscal year rose at the fastest pace in twenty-three years. These are not the trappings of a weak economy.
Within this tax-revenue story, employment tax receipts are now rising faster than nominal growth of gross domestic product, a sign that real wages are rising again. Total tax receipts climbed $273 billion during fiscal 2005, marking the fastest annual change in receipt growth since 1982 when the economy was recovering from the worst recession since the Great Depression. Real receipt growth (tax revenues adjusted for the consumer price index) has been rising at a pace not seen in more than three decades. Booming revenues pushed the fiscal deficit for fiscal 2005 down to $317 billion (2.6% of GDP) from $413 billion during fiscal 2004 (3.4% of GDP). Tax receipts from business and employment also continue to advance at a strong pace.
Since workers don’t have an incentive to pay taxes on wages not earned, and corporations don’t have an interest in paying taxes on phantom profits, the tax-revenue trends suggest that household and corporate incomes remain quite strong. The data also suggest that with growth in excess of 30 percent in non-withheld receipts (i.e., capital gains and dividends), the 2003 tax cuts have not drained revenues. Rather, they have added to them. Total equity market capitalization has risen by $3.9 trillion since the tax cuts were passed. At a static “cost” of $350 billion, each dollar of static tax cut has increased the value of the capital stock by $11.
In other words, the tax cuts have generated a positive revenue reflow effect on both a balance-sheet and cash-flow basis. This is another reason for the Republican leadership in Washington to drop the histrionics over deficits and redouble their efforts to make permanent the 2003 tax-cut package that has been instrumental in producing these results.
— Michael T. Darda is the chief economist and director of research for MKM Partners, an equity execution and research boutique located in Greenwich, Conn. He welcomes your comments here.