Small Business Tax Credits Won’t Create Jobs

The jobs numbers were lousy (as we predicted). The Administration’s solution is small business tax cuts. While this is a good idea in the long haul, it is not a solution to the short-term problem. Simple logic says you don’t hire a worker or invest in a piece of equipment that doesn’t pay for itself. Economists teach this.

The top problem faced by small business owners today according to the National Federation of Independent Business is “weak sales” (not credit availability). Translation: new workers can’t produce enough sales to cover the cost of hiring them. New equipment can produce more output, but it can’t be sold, so capital spending projects wont pay for themselves. Thus, hiring or buying new productive capacity would produce lower profits as the cost would exceed the revenue generated.

So, the basic problem is that resources can’t produce sufficient income to pay for themselves. This is true no matter how it is financed.

1. Tax cuts may give the firms more cash, but why would they spend it on employees or equipment that won’t pay for itself? These “gifts” will still be invested only when the prospect of a payoff is good. It would be crazy to do otherwise.

2. Job tax subsidies make an employee cheaper for a short period but again the employee must be able to generate enough income to pay their way or the firm loses more money.

3. How about interest-free loans? Nope, since the money must be repaid, why invest it in losing endeavors?

The Administration doesn’t understand basic business and the nature of the problems faced by owners. Consequently it designs “stimulus” programs that are counter-productive and wasteful of taxpayer money.

April Retail Sales Were Simply Fabulous

The news from the Census Bureau on May 14 about April retail and food services sales was just stunning. Total retail and food services sales in April were $366.4 billion after adjustments for seasonality, trading days and the very important Easter holiday period.

That total was up 0.4 percent from the upwardly revised March level and it was an eye-catching 8.8 percent above April 2009. Not only was that the biggest year-over-year increase in ages, but also every single category posted annual gains.

The lowest annual increase was in the hard-hit department stores category. They were up only 0.9 percent. The biggest increase was the 30.1 percent racked up by gasoline stations. That was almost all a reflection of higher crude oil prices this year.

Auto and other motor vehicle dealers were up 16.9 percent. Nonstore retailers were up 12.9 percent.

The long-suffering “Building materials and garden equipment and supplies dealers” category had growth of 12.1 percent. That pulled their total for the first four months of the year up to 2.9 percent above the same period of 2009.

These results were the second-best April in history. They were only $1.0 billion below the April 2007 record of $367.4 billion. They also exceeded every other month since September 2008. All the data back to 1992 were revised last week. History is always changing with economic data.

This is a wonderful start to the second quarter. The recovery remains firmly on track despite all the global turmoil.

You Call That Repayment, GM?

GM is running TV ads claiming that they have repaid their government TARP loan of $8 billion and change early. Eight billion? The taxpayers invested $80 billion of TARP money into GM and Chrysler, most of that to GM. How does $8 billion pay that off? It doesn’t. What it bought us is 61% ownership in the new GM and a block of stock for the UAW. Previous shareholders and bondholders got virtually nothing.

So what is that stock worth? General Motors recently reported a LOSS of over $4 billion dollars, not a great return on the tens of billions of dollars taxpayers “invested” in the car companies (not voluntarily of course–no sane private investor would have invested in them which is why the government had to). With profits like this, the share price will surely fail to rise to the historically high levels needed to insure a return of taxpayer money.

The problem could get even worse over the long term. The GAO has reported that the auto industry pension funds (for 900,000 workers) are underfunded by $17 billion. Payments of about $15 billion have to be made in the next few years to the pension funds. Let’s just say it will be hard to make these payments with no earnings. The company continues to liquidate itself, but now they are losing taxpayer money. The government’s clear preference for unions in all these dealings suggests that more taxpayer money will ride to the rescue in the years to come.

If the company was doing something of value (to us) and doing it well (making money), we might be happy to see the debts being repaid out of earnings. But that’s not happening and may never happen.

Short-term Tax Incentives Don’t Work

Congress has undertaken a series of attempts to stimulate consumer spending by providing tax breaks for actions taken before a certain date. First came the $8,000 tax credit for buying a new home. This was followed by “Cash for Clunkers”. And now Congress is contemplating a tax credit for hiring new workers. And there may be more ill-conceived plans to entice the consumer to spend more. It was, after all, a sharp decline in consumer spending that led us into a deep recession.

There are several important facts of life to recognize in evaluating these schemes. First, none of these plans will get someone to buy a house, buy a new car or hire an employee that wasn’t going to do so anyway in the time period close to the passage of the program. No one spends $200,000 on a house just to collect $8,000, a small percentage of the house price. The same was true for Cash for Clunkers. It is very likely that all consumers who participated in the program would have purchased a vehicle in the proximate time period without the program. All these programs did was to pull future demand into the current period, reducing future demand, a fact revealed by the precipitous decline in home purchases once the credit ended. Bottom line, the two programs were just gifts from taxpayers to consumers who would have made purchases anyway.

A proposed $5,000 tax credit for hiring a new employee will have the same result. No business will spend a salary of $30,000 or $40,000 or whatever to get a $5,000 credit which lasts only a short period of time, leaving the firm to pay the full cost in the future. Once again, such a program would just be a gift from taxpayers to firms that would have hired anyway. It will rearrange the pattern of hiring, but not increase it.

The most recent report on housing starts indicated that little was happening there. In a normal year, we would build over one and a half million new housing units. Current starts are under 600,000, because over 10 percent of all housing units are still vacant. Housing will come back, but slowly, and this is one reason why the recovery from the recession will be slower than hoped for.

“Crowding Out”: Coming Soon to a Lender Near You

In a “closed economy,” savings is the source of all capital (textbook: “a country can invest no more than it saves”). With open economies, there is the possibility to tap the savings of other countries. It is the ability of the U.S. to borrow from the rest of the world that has permitted us to have solid growth in consumption as well as in investment (new homes construction, commercial construction, industrial equipment, etc.) which has amounted to around 15 percent of GDP while our savings had amounted to substantially less.

The economy imploded in the fourth quarter of 2008 when consumers decided to move their savings rate (out of disposable income) from near-zero levels to around 5 percent. (Sounds good but it’s nothing to brag about. In the late 1970s, the US savings rate was over 10 percent.) This meant that retail sales declined by hundreds of billions of dollars, starving the bloated number of strip malls, retailer outlets and restaurants built to feed our partying during the 2003-07 period. Click here to read the full post and comment (Insights subscribers) »

How to Get Banks to “Right-Size” Themselves

As a reminder, Dr. Dunkelberg serves as Chairman of the Board of Liberty Bell Bank.

Assuming that regulators decide that banks are indeed too large, how might a reduction in size be accomplished? There is already in place a limit on the share of domestic deposits a bank may have (although recent “resolutions” of troubled banks have resulted in these limits being exceeded). But banks were able to grow using foreign deposits (not insured by the FDIC) and by issuing bonds (guaranteed by the FDIC until recently). To be more effective, setting a minimum level for the ratio of core deposits to assets would limit growth funded by bank debt or foreign deposits and reduce leverage. For community banks, this ratio is very high since few issue bonds or have foreign deposits.

Capital requirements should also be increased with asset size. This will discourage growth since it lowers the return on capital unless increased size really produces the cost economies or extra revenues that supporters of big banks argue are present. Federal Reserve research suggests cost economies disappear at around $10 million in assets, but there is disagreement. By increasing capital requirements, banks won’t grow unless it really pays.

FDIC insurance charges should be applied to assets (less capital) instead of core domestic deposits. It is the assets that put the deposits at risk, so the insurance tax should be applied there, and should be raised as the assets carried on the balance sheet of the bank become more complex and opaque.

Off-balance sheet and “repo” activities should be more transparent and better monitored, making them more difficult to execute, and therefore rarer. These can’t be used by banks to avoid compliance (for example, by temporarily offloading those “troubling assets” that might violate regulations in a repo in exchange for wonderful cash or Treasury securities).

These regulatory changes would raise the cost of getting large, force the capital increases needed as risk rises, and force banks to actually realize the cost savings or benefits allegedly produced by “bigness” so that the return on investment will not be compromised. Regulators would not need to arbitrarily set limits on bank size since the regulations would compel banks to raise capital as needed and realize alleged scale economies to maintain a competitive return on investment. With regulations like these in place, very large banks would either prove to be profitable while being better capitalized and less risky or they would have to shrink, reduce leverage and opacity to earn a competitive return for shareholders. This is just what the “regulator doctor” ordered.

The US Economy Keeps Rolling Along

Yesterday, the BEA released the first (“Advance“) estimate of GDP for the first quarter of 2010. My forecast for 3.0 percent real GDP growth at a seasonally adjusted annual rate (SAAR) was very close to their published 3.2 percent. It’s always a good feeling to be so close to what the BEA gives us.

This is a far more sustainable pace than the 5.6 percent at a SAAR real GDP growth rate of the fourth quarter 2009. Most forecasters believe 3.2 percent is about the long-run potential growth rate for the US economy. Of course, we should be able to exceed that for two or three years as we make up all the slack in the economy caused by the 2007-2009 recession. Click here to read the full post and comment (Insights subscribers) »

Retail Sales Were Very Good in March and the First Quarter

The Census Bureau reported that total retail and food services sales in March were $363.2 billion on a seasonally adjusted basis. That was up 1.6 percent from February and a huge 7.6 percent from a year earlier. It was the best month for this very important part of the US economy since September 2008. That level was $365.9 billion. That was also the month when the collapse of Lehman Brothers pushed the entire world into a financial crisis. So, at least in nominal terms, retail sales are finally back.

Total retail and food services sales for the first quarter were $1.1 trillion. This was up 5.5 percent from the same period in 2009.

Every major category of retail posted higher sales this March than last. Only two major categories were lower in the first quarter than a year earlier. These were electronics and appliance stores (-1.6 percent) and building materials and garden equipment and supplies dealers (-3.1 percent). The former group probably had lower nominal sales because of the huge price decline in high-definition big screen television sets and other electronic equipment. The latter group continues to struggle with declining housing completions.

Gasoline stations posted a 26.7 percent increase from a year earlier in the first quarter. That reflects higher gasoline prices.

Nonstore retailers were up 12.3 percent for the quarter. That shows the continued popularity of catalogs and the internet.

Motor vehicle dealers saw an 8.8 percent rise in the first quarter. That came despite all the problems of Toyota.

Even furniture and home furnishings stores were up 0.9 percent for the quarter. That’s their first increase in a long time.

Since consumer spending accounts for 70.0 percent of total GDP, these robust results are very good news indeed. Get out there and keep shopping–the country needs the growth!

Inflation Is No Problem Now

On April 14, the BLS gave us the CPI data for March. A surge in the “Fresh Fruits and Vegetables” index lifted the total to 217.631 (1982-1984=100), up 2.3 percent from a year earlier.

However, the CPI-U less food and energy index was 221.059, up only 1.1 percent from a year earlier. Click here to read the full post and comment (Insights subscribers) »

Industrial Production Is Rebounding As Well

If you want to look for clear evidence of a V-shaped recovery, then the industrial production (IP) statistics are a great place to visit. On April 15, the Federal Reserve Board released the latest in a string of strong reports on this critical part of the US economy. Click here to read the full post and comment (Insights subscribers) »