A number of recently released housing statistics show continued positive progress in this sector. The most recently released Case-Shiller Index shows improvement in 95% of U.S. markets.1 Home prices are up an average of 2.1% over the previous year. Sales of existing homes in October were up 10.9% from October 2011. October saw 2.14 million existing homes on the market, the lowest level since February 2006. Lastly, November home builder confidence jumped to its highest level since 2006.2 The general consensus amongst economists shows growing optimism regarding this sector. It is now becoming common to hear that we have passed the bottom of the housing dip.
There is a pent-up demand for housing from both delayed household formation and caution towards entering the housing market. Analysts have been keeping a watchful eye on the sector as a change in these behaviors is expected sooner rather than later. Housing starts in the spring of 2013 will be eyed carefully as they are a bellwether of builder confidence. There is a fair degree of optimism within the economic reports related to housing; however, this optimism can only be described as guarded.
Domestic Oil Production
“The U.S. Is the New Saudi Arabia”
You likely have seen a headline or two similar to the above. Due to modern innovations such as horizontal drilling and hydraulic fracking, domestic production of oil and natural gas has increased dramatically and is expected to continue to increase. Recent reports point to the U.S. producing as much oil as Saudi Arabia by 2020.3 Having this much oil come from North America would simplify the buying process. The current Middle Eastern oil producing countries often have stability issues. For example, the recent ramp up in conflict between the Palestinians and Israelis could escalate and affect the ability of regional exporters to ship oil to the United States. Greater domestic production means less worry in times of instability.
The focus in Washington, D.C. has now shifted from the election to the budget. While the budget discussions continue, there is an issue I haven’t seen addressed in the general media. Even though we have seen weak employment growth, tax collections have ramped up considerably since the recession. The government received about $2.5 trillion annually in 2006 through 2008.4 This dropped to about $2.1 trillion in 2009 and 2010. The federal government’s fiscal year ends in September, meaning final 2012 figures can now be calculated. A recent Congressional Budget Office (CBO) release of these 2012 figures shows about $2.4 trillion in revenue received, a return to pre-recession levels.5 The increase has come from both corporate and individual taxes. This is not an expected change given the continuing high unemployment rate and slow corporate recovery. While federal revenue has returned to pre-recession levels, governmental expenditures have not.
It is impossible to have an economic newsletter at this time and not mention the “fiscal cliff.” Deadlock within the government has led to budget agreements that have been temporary in nature rather than permanent. These temporary fixes are set to expire at the end of the year, dramatically changing a budget landscape by returning tax rates to 1990’s levels. If no agreements are reached by the end of the year then all categories of taxpayers will see their rates return to levels paid during the Clinton Era. Government spending will also return to Clinton Era levels. We would see all taxpayers pay higher taxes, Medicare payments reduced to doctors, significant defense spending cut, cuts to educational programs, etc. Industries and citizens linked to the military would be hit especially hard as defense comprises a large portion of federal spending. In short the economic landscape would be rolled back to a 1990’s scenario. It would have a greater impact on middle income Americans than is desired by any side of the fiscal debate. That impact is what the various parties are negotiating to avoid.
Going over the fiscal cliff is not an apocalyptic scenario for the country as a whole. It would significantly increase tax revenue and reduce governmental expenditures, particularly in defense. It would definitely address the deficit issues that have been created since the 1990’s. The problem is that it would not do so in a smooth and measured manner. You may recall that a 2% reduction in social security payroll taxes was instituted during the recession. This is 2% of a wage earner’s annual income, thus giving a 2% boost in take home pay targeted to lower income households. It is one of the items that would be rolled back without a budget agreement. Current dividend and capital gains taxes would increase to levels present in 2000. Capital gains tax rates would rise from 15% to 25%. Dividends would return to being taxed as regular income. The defense industry is based on current military spending, which would decrease. The list of categories of businesses and individuals who would have to adapt rapidly to a greatly changed landscape is quite long. While it is too early to tell what shape a budget agreement might take, Congress is widely expected to address the fiscal cliff issue before the January 1 deadline.
The government continues to spend more than it receives, creating historically abnormal deficits. The situation has exaggerated during the drop in the economy. The CBO’s November 8th Monthly Budget Review notes a 1.7% decrease in outlays for 2012. Outlays have fallen from 24.1% of GDP in 2011 to 22.8% in 2012. This is still above the 40-year historical average of 21.0% though. From 2011 to 2012, spending on Medicaid dropped by 9%, unemployment benefits by 24%, defense by 3%, and interest on public debt by 3%. However, these positive trends were offset by some substantial spending increases. Increases in TARP spending were greater than the savings from unemployment, defense, and interest payments. Increases in social security and Medicare were far greater than the savings in Medicaid.6 And while the deficit grew by less than it had the previous year, it still grew. This is not a sustainable course of action.
Morningstar recently published a conversation with four economists from the University of Pennsylvania’s Wharton School of Business, a well-respected school. While they noted the short-term fiscal cliff issue, they were each more concerned with long-term economic stability. The causes of the current deficit were their main concern. Issues they have identified are Medicare and Social Security reform, tax code reform, mortgage market (including Fannie Mae and Freddie Mac), and cooperation within government. Some of the issues of interest they noted are:
Medicare & Social Security – There were 5 non-elderly adults in this country for every person over 65 in 2010. This ratio will change to 3 non-elderly for each person over 65 by 2030.7 The working populace cannot sustain the current level of payments to retirees. This issue is tricky as the elderly will need to receive an adequate level of support. Some proposed ideas are greater use of technology in medical administration, limiting eligibility for medical testing, limiting access to unproven and expensive medical procedures, increasing the cap on taxable social security wages, and other controversial issues. Reducing outlays while preserving services for seniors will be difficult but is necessary.
The Institute of Medicine noted in September that about 30% of every medical dollar spent in this country is wasted.8 The head of Medicare and Medicaid from 2010 through 2011 has noted that those programs hold true to this figure and estimates the cost at $150 billion to $250 billion for taxpayers.9 The five main causes of waste are overtreatment, preventable errors and mistakes, complex and cumbersome administration, regulatory burden (in part to prevent lawsuits), and fraud.
Tax Code Reform – Upper income earners will likely be paying higher taxes in the future. However, allowing top marginal tax rates to revert to pre Bush-era levels will only address a small portion of the deficit as this will only raise an average of $85 billion per year over the next 10 years.10 The deficit is projected to be near $1.1 trillion for just 2012, meaning the upper income tax increase will only address about 8% of the deficit.4 Allowing capital gains and dividend tax rates to revert to pre–Bush-era levels would generate $8 billion, or less than 1% of the deficit.11
The U.S. corporate and individual tax codes are in need of revisions as they have decades of lobbyist-induced tax breaks for a wide variety of items. Each deduction has someone or group who benefits, though. It is hard to get lawmakers to agree to remove these items in reality.
Mortgage market – While the national housing situation has improved, it is still a significant black mark on the economy. The average credit score of rejected applicants for loans backed by Fannie Mae and Freddie Mac is 760.7 This is higher than the average score of accepted applicants in previous years. Lenders are still unwilling to loan to many sectors of the populace. Investors are still largely unwilling to hold mortgage-based securities (MBS). In fact, annual issuance of MBS has dropped from over $1 trillion in 2005 to about $1 billion currently.7 This stagnation of the housing sector is a drag on employment recovery.
Unemployment is still high at near 8%. Underemployment is harder to track but is undoubtedly at a far higher rate. Tax increases on upper income earners are likely at this point. These increases have to be accompanied by reductions in spending. While it is heartening to see budget deficits decreasing and smaller than projected, we are still running record high deficits every year. We cannot continue to spend significantly more money than we receive in tax revenue. While some revenue changes can and will occur, there is a limit to how much tax increases can be expected to contribute to reducing deficits.
2) Housing Industry is Looking Better, Los Angeles Times, November 20, 2012
3) Saudi America, The Wall Street Journal, Review & Outlook, November 12, 2012
4) The Hard Fiscal Facts, The Wall Street Journal, Review & Outlook November 12, 2012
5) Monthly Budget Review Fiscal Year 2012: A Congressional Budget Office Analysis, October 5, 2012
6) Monthly Budget Review, Congressional Budget Office, November 7, 2012
7) What now, Mr. President?, Morningstar, November 7, 2012
8) Report: US health care system wastes $750B a year, Yahoo! News, September 6, 2012
9) High Level of Waste in Health Spending, Says Medicare and Medicaid Boss, http://www.medicalnewstoday.com, December 5, 2011
11) The Big Picture, Briefing.com, November 20, 2012
The information contained in this newsletter is for general use, and while we believe all information to be reliable and accurate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax or legal advice and may not be relied upon for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a solicitation of the purchase or sale of any securities.
Some clients have commented on the declining frequency of newsletters from our office over the past year. We have had to shift some resources in order to deal with changes in our internal business structure due to a combination of business growth and industry-wide regulatory changes. We do feel newsletters are an important communication tool to help keep clients abreast of current economic issues and are looking at ways to restore the frequency to former levels. We do appreciate your patience as we address this issue. There are a number of economic issues I find interesting at the moment, including some positive economic developments.