The State and local sector Essay

the BUSINESS SITUATION



REVISED (45-day) estimates show that real GNP increased at an
annual rate of 2 percent in the third quarter of 1984 (table 1).
Preliminary (15-day) estimates, published a month ago, had shown a 2
1/2-percent increase.1 The only sizable revisions were an upward
revision of $3 1/2 billion in nonresidential fixed investment (mainly
due to a revision in producers’ durable equipment) and a downward
revision of $4 billion in net exports (due to a downward revision in
exports and an upward revision in imports). A small upward revision in
personal consumption expenditures was more than accounted for by
services. Small downward revisions were in residential investment,
change in business inventories (due to nonfarm inventories), and
government purchases (more than accounted for by national defense
purchases). The GNP fixed-weighted price index, which registered a
4-percent increase in the third quarter, was revised little.

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1. Quarterly estimates in the national income and product accounts
are expressed at seasonally adjusted annual rates, and quarterly changes
in them are differences between these rates. Quarter-to-quarter percent
changes are compounded to annual rates. Real, or constant-dollar,
estimates are expressed in 1972 dollars.



Overall, the economic picture presented in the October
“Business Situation’ has not changed significantly. The
third-quarter increase in real GNP was a marked slowdown from increases
of 7 percent and 10 percent in the second and first quarters,
respectively. A swing in final sales–to a small decline after a sharp
increase in the second quarter–more than accounted for the
third-quarter deceleration in GNP; an increase in inventory investment
provided only a partial offset. Within final sales, all components
contributed to the third-quarter swing; personal consumption
expenditures contributed nearly onehalf and net exports more than
onefourth.


Corporate profits



Profits from current production– profits with inventory valuation
adjustment (IVA) and capital consumption adjustment (CCAdj)–declined $9
1/2 billion in the third quarter, to $281 1/2 billion, following a $13
1/2 billion increase in the second quarter. Domestic profits of
financial corporations were down $2 billion; those of nonfinancial
corporations, $7 billion; and profits from the rest of the world, $1/2
billion. Occasional dips in profits are not uncommon as expansions
mature; therefore, it is too early to say whether profits have peaked
yet for this expansion. Even after a peak in profits, however, GNP has
typically continued to expand for several quarters.



The decline in profits follows six quarters of consecutive
increases and reflects the progressive slowing of real GNP in 1984. Real
corporate product also slowed. In the third quarter, it increased 1/2
percent, following six quarters of growth that ranged from 4 1/2 to 15
percent.



Per unit profits declined, more than offsetting the slight increase
in real product. Costs incurred and prices received by corporations per
unit of real product were up, but the increase in costs exceeded that in
prices. Both labor and nonlabor costs increased– labor costs by more
than twice as much as nonlabor costs.



Adjustments to profits.–Profits before tax–profits without IVA
and CCAdj–declined $22 1/2 billion to $223 1/2 billion, following a $2
1/2 billion increase in the second quarter. The IVA and CCAdj convert
inventories and depreciation reported by business to those used in the
national income and product accounts (NIPA’s). The CCAdj was up $6
billion, following a $4 1/2 billion increase; the increases mainly
reflected the effect of shorter service lives for depreciation of
capital permitted under the Economic Recovery Tax Act of 1981. The IVA
again increased, by $7 billion, reflecting smaller increases in
inventory prices. In the second quarter, it had increased $6 billion.



Disposition of profits before tax.– Corporate profits tax liability declined $11 1/2 billion, to $84 1/2 billion, following a $3
billion increase. The 1984 quarterly estimates incorporate the effects
of the tax changes resulting from the Deficit Reduction Act of 1984.
(For a detailed explanation of the changes and their effects, see the
August 1984 issue of the SURVEY.) The third-quarter decline in tax
liability reflected the decline in profits before tax. Dividends were
up $1 1/2 billion, to $81 1/2 billion, following a $2 billion increase.
Undistributed profits were down $12 billion, to $58 billion, following a
$2 1/2 billion decline.


Profits by industry.–Profits with IVA but without CCAdj–the
variant of profits available by industry–declined $15 1/2 billion in
the third quarter, to $223 1/2 billion, following a $9 billion increase
in the second quarter.



Domestic profits of financial corporations were down $2 billion, to
$27 billion, following no change. Savings and loan associations’
profits more than accounted for the decline.



Domestic profits of nonfinancial corporations declined $13 billion,
to $176 billion, following a $13 billion increase. Manufacturers’
profits accounted for about three-fourths of the decline. Within
profits of manufacturers of nondurable goods, declines were widespread;
profits of manufacturers of petroleum and coal products and of chemicals
and allied products accounted for most of the decline. Profits of
durable goods manufacturers changed little.



In nonmanufacturing industries, decreases in trade and in the
transportation, communication, and utilities group more than offset a
small increase in other nonmanufacturing industries. Within trade,
retail trade more than accounted for the decline. The change in these
profits is consistent with the third-quarter slowing in personal
consumption expenditures.



Government Sector



The fiscal position of the government sector in the national income
and product accounts (NIPA’s) deteriorated in the third quarter, as
the combined deficit of the Federal Government and of the State and
local governments increased $24 billion. The deterioration occurred at
both levels of government: The Federal Government deficit increased,
and the State and local government surplus declined. However, at $131
billion, the combined deficit was lower than a year earlier. This
improvement was more than accounted for by a $4 billion decline in the
Federal deficit.



The Federal sector



The Federal Government deficit increased $13 billion in the third
quarter to $177 billion, as expenditures increased more than receipts.
Receipts increased $3 billion, compared with $18 billion in the second
quarter. The slowing was largely due to corporate profits tax accruals,
which declined $9 billion–reflecting the drop in corporate
profits–after a moderate increase. Personal tax and nontax receipts
again increased $9 billion. Contributions for social insurance
increased $3 billion, and indirect business tax and nontax accruals
increased about $1/2 billion, both somewhat less than in the second
quarter. In the latter, a $1 billion increase in customs duties and
nontaxe was partly offset by a decline in windfall profit taxes.



Expenditures increased $16 1/2 billion, compared with $20 1/2
billion in the second quarter. Net interest paid increased $11 billion,
accounting for over two-thirds of the increase in total expenditures.
Nondefense purchases increased $7 billion: Purchases by the Commodity
Credit Corporation (CCC) increased $5 1/2 billion, and all other
purchases increased $1 1/2 billion. The increase in CCC purchases was
largely the result of regular operations; PIK transactions accounted for
less than $1 billion. Transfer payments to persons increased $2 1/2
billion; a $3 billion increase in Social Security benefits was partly
offset by a $1/2 billion decline in unemployment benefits.



All other categories of expenditures declined. Subsidies less the
current surplus of government enterprises declined $2 1/2 billion,
reflecting declines in the CCC deficit ($1 1/2 billion) and in
agricultural subsidies ($1/2 billion). Grants-in-aid to State and local
governments declined $1 billion, and transfer payments to foreigners and
national defense purchases declined $1/2 billion each. The decline in
national defense purchases was more than accounted for by a significant
falloff in the delivery of all types of military equipment (see table 2
on page 9).



Cyclically adjusted budget.–When measured using cyclical
adjustments based on middle-expansion trend GNP, the Federal fiscal
position moved from a deficit of $165 billion in the second quarter to a
deficit of $173 billion in the third (see table 3 on page 10). The
cyclically adjusted deficit as a percentage of middle-expansion trend
GNP increased from 4.5 percent in the second quarter to 4.7 percent in
the third–a move toward a more expansionary fiscal position.



Fiscal year 1984.–For fiscal year 1984, which ended September 30,
the Federal Government deficit (on the NIPA basis) amounted to $171
billion, slightly higher than the deficit projected in the mid-session
review of the unified budget (see the August SURVEY for details of the
midsession review). Receipts were $6 billion lower, and expenditures
were $5 billion lower, than previously estimated.



The State and local sector



The State and local government surplus declined $8 1/2 billion in
the third quarter to $46 billion, as expenditures increased
significantly more than receipts. A large decline in the surplus of
“other’ funds was partly offset by an increase in the surplus
of social insurance funds.



Receipts increased $2 1/2 billion, compared with $11 billion in the
second quarter. The slowing was largely due to declines in corporate
profits tax accruals ($2 billion) and in federal grants-in-aid ($1
billion). Indirect business tax and nontax accruals increased $3 1/2
billion; property taxes and sales taxes contributed $2 billion and $1
1/2 billion, respectively, to the increase. Personal tax and nontax
receipts and contributions for social insurance increased $1 billion
each.



Expenditures increased $11 1/2 billion, slightly more than in the
previous quarter. Purchases of goods and services more than accounted
for the increase; all other expenditures, on balance, declined $1/2
billion. Within purchases, compensation increased $4 1/2 billion,
construction increased $4 billion, and all other purchases increased $3
billion. More than one-half of the increase in construction was
accounted for by highway construction, which has increased sharply–$5
billion –since the first quarter of 1984.



Alternative measure of fiscal position. –Table 2 updates the
alternative measure of the State and local government fiscal position
introduced in the March 1984 SURVEY. The update incorporates the NIPA
revisions of July 1984, recent flow-of-funds revisions by the Federal
Reserve Board, and preliminary 1982-83 Governmental Finances data from
the Census Bureau. The basic fiscal position of State and local
governments as shown by the alternative measure is the same as shown in
the March presentation: State and local governments recorded deficits in
1981 and 1982 and then swung to surplus in 1983. However, the fiscal
position in 1981 looks better than previously estimated, but the deficit
in 1982 is $6 1/2 billion higher, and the surplus in 1983 is $5 1/2
billion lower, than previously estimated.



November ballot highlights.–A number of state and local tax and
expenditure issues were up for voter consideration in November. Major
limitations on taxes, expenditures, or both, appeared on ballots in
California, Michigan, Nevada, and Oregon; all were defeated. Proposals
to increase general sales taxes were defeated in Arkansas and West
Virginia, as was a proposal to exempt grocery food from sales tax coverage in Idaho. In contrast, voters approved several bonded debt
issues and lotteries.



Bond issues on the ballots totaled almost $5 billion, the largest
volume of issues offered for approval since 1975. The largest issues
approved were $2 1/2 billion in California for water conservancy and
pollution control, schools, veterans’ loans, and hazardous waste cleanup, and over $1/2 billion in Alaska for financing veterans’
housing. Over $1/2 billion in new issues were rejected; major turndowns
were in Arkansas (for waste disposal) and West Virginia (for a variety
of projects). Four States–California, Missouri, Oregon, and West
Virginia –approved new lotteries. When the new lotteries are in full
operation (probably in the fiscal year beginning July 1986), it is
estimated that they will add a total of $1/2 billion annually to state
revenues.



Table: 1.–Revisions in Selected Component Series of the
NIPA’s, Third Quarter of 1984



Table: 2.–Derivation of an Alternative Measure of the State and
Local Government Fiscal Position, 1980-83

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