Thursday, July 29, 2004

Bubble Watch: IRS Tax Receipts Show Crash

One of the arguments between market watchers and economists is whether a market correction is simple a market fluctuation or has real impact on the "main street" economy. The answer it seems is that it does, but that usually that affect isn't noticeable unless the correction becomes a crash. The NYT reports that the IRS has reported income declining.

(How does the Bush Tax cuts play into this? A: None as far as I can tell, because the IRS is reporting income declining as well as tax receipts, to be fair tax receipts are higher than expected this year.)

Published: July 29, 2004

The overall income Americans reported to the government shrank for two consecutive years after the Internet stock market bubble burst in 2000, the first time that has effectively happened since the modern tax system was introduced during World War II, newly disclosed information from the Internal Revenue Service shows.

The total adjusted gross income on tax returns fell 5.1 percent, to just over $6 trillion in 2002, the most recent year for which data is available, from $6.35 trillion in 2000. Because of population growth, average incomes declined even more, by 5.7 percent.

Adjusted for inflation, the income of all Americans fell 9.2 percent from 2000 to 2002, according to the new I.R.S. data.

While the recession that hit the economy in 2001 in the wake of the market plunge was considered relatively mild, the new information shows that its effect on Americans' incomes, particularly those at the upper end of the spectrum, was much more severe. Earlier government economic statistics provided general evidence that incomes suffered in the first years of the decade, but the full impact of the blow and what groups it fell hardest on were not known until the I.R.S. made available on its Web site the detailed information from tax returns.

The unprecedented back-to-back declines in reported incomes was caused primarily by the combination of the big fall in the stock market and the erosion of jobs and wages in well-paying industries in the early years of the decade.

In the past, overall personal income rose from one year to the next with relentless monotony, the growth rate changing in response to fluctuations in economic activity but almost never falling...

Before the recent drop, the last time reported incomes fell for even one year was in 1953. The only other time since World War II that the I.R.S. reported an interruption in income gains was from 1947 to 1949, but that was because of changes in the tax law at the time that affected how income was reported rather than an actual fall.

From 2000 to 2002, individual income taxes fell 18.8 percent, more than three times the decline in adjusted gross incomes, the I.R.S.'s latest statistical reports show. (Adjusted gross income is the broadest category of income taxpayers report to the government, excluding only a small portion of income in other forms, notably interest on tax-free bonds.)

Spencer England has recently sent me a paper he wrote detailing why he felt that the S&P500 hadn't been over-valued. I don't think there's necessarily a contradiction here, because it was the NASDAQ that was hit the hardest and was the most bloated. However it seems that this "hi-tech" segment of our society truly was overloaded and overhyped.

A genuine asset inflation bubble seems to have formed, and when it crashed it depressed actual income levels. The actions of the Federal Reserve in lowering interest rates in light of that were necessary, but in the context of a dysfunctional monetary supply, currency, and fiscal situation there were perhaps no right answers to what the FOMC should have done only least wrong ones. In a similar vein, Greenspan may be choosing to save GDP now but the choice of doing so is to continue a situation where the long term fiscal structure of the USA is undermined steadily. Without a budgetary and national debt solution, and absent the political will to restructure the economy through painful policy choices, Greenspan and co. seem to be merely playing a delaying game and hoping for the political situation to rectify itself. Perhaps they are even correct.

What still remains disturbing however is their rhetoric rationalizing as beneficial these choices. Perhaps this news meant for public consumption is meant to prevent a panic, but the very obliviousness it promotes lends itself to moral hazard and the very self-fulfilling prophecy of the long term financial crisis and fiscal default the Federal Reserve is surely attempting to avoid. It also brings into question the probity of the Federal Reserve, since it leads critics to question whether the Federal Reserve actually believes its own rhetoric and understands the seriousness of the long term situation.


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