Three Data items today, with two observations about US tax policy bookending a look at 2- and 3- year Treasury yields:
#1: The relationship between Federal tax receipts and the size of the US economy. With tax policy likely to become a major political and capital markets issue in the coming months, it’s important to understand how these two variables relate to each other.
Here is the ratio of US governmental tax receipts to US GDP back to 1929 with 2010’s 14.4 percent low point noted to give you a sense of scale and historical reference:
Three things about this relationship:
First, you can see it has been remarkablely stable since the 1950s. Aside from that Great Recession low, Federal tax receipts have moved in a reliable band of 15 – 20 percent of GDP for going on 70 years. Marginal individual and corporate tax rates have varied considerably over the period, but it has not mattered very much in terms of how much GDP ends up going to Washington.
Second, economic growth is actually the best way to generate marginal tax receipts. That peak you see just before the 2000 recession bar is for 1999, with 19.8 percent of GDP going to the Federal government. This was due to a combination of record-high labor force participation and capital gains from the Internet 1.0 stock market boom. More generally, every cycle’s peak tax/GDP ratio came towards the end of an economic expansion (1952/1953, 1969, 1974, 1981, 1989, 1999, and 2007).
Lastly, 2020 wasn’t anywhere near as bad for Federal tax collections as the Great Recession, but we need to put an asterisk there. At 16.3 percent, this ratio is actually higher than 2018 (16.16 percent) and 2019 (16.15 percent). But how this ratio came about – large fiscal stimulus to support the economy – is not comparable to prior periods.
Takeaway: one point of US GDP is $200 billion, so there is some room to tweak Federal tax policy in order to increase receipts and reduce budget deficits, but 70 years of history shows the limits of what is possible in this regard.
#2: We’re keeping a weather eye on Fed Funds Futures and shorter-term Treasury yields going into Wednesday’s FOMC meeting and Fed Chair press conference.
The odds of a rate increase in 2021 increased today to 10 percent from 4 percent on Friday. As we mentioned yesterday, these probabilities have been banging around 5-10 percent for a few weeks. Still, it is noteworthy that they moved today – just 2 days before a press conference that should reassure markets of no policy shift until 2022.
Separately, let’s consider what 2- and 3-year Treasury yields might be saying about not just when the Fed starts to move rates but how quickly they raise them once they start. The chart below shows 2-year yields in red and 3-years in blue.
Notice that 3-year yields have started to decouple quite dramatically from 2-years. At the start of 2021, the difference was just 5 basis points and 2-years yielded 0.11 percent. Now, the difference is 20 basis points and 2-years still only yield 0.14 percent. Those 2-year yields fit with the Fed’s stated intent of keeping policy rates at 0 – 25 basis points until the US economy is on far stronger footing. But the lift in 3-year yields since the start of 2021 says that once they fulfill that goal rate policy will begin to normalize quickly.
Takeaway: when you’re coming off zero interest rates, there is a big difference between one or two 25 basis point moves/year in Fed Funds and three or four a year. Treasury markets, like Fed Funds Futures, are taking the Fed at their word about 2021 – 2022 policy. But the question of “what happens after that” is an important one. If markets grow more concerned about inflationary pressures, they will assume Fed policy will need a catch-up phase of uncertain timing and magnitude.
#3: We’re also keeping tabs on US tax refund season, actually a larger check for many US households than the much-discussed stimulus payments currently being distributed. Week 3 data was out today:
- Good news: average refund size remains essentially the same as 2020 at $2,990, down just 0.7 percent.
- Bad news (1): tax season is off to a very slow start in 2021, so there have been 25 percent fewer returns filed this year than on the equivalent day in 2020. This will delay refund checks getting into the hands of taxpayers owed money by the US Treasury relative to prior years.
- Bad news (2): the number of refunds is down 32 percent, more than the decline in returns filed. Early days yet, but this points to the possibility that many Americans who customarily get a refund will not receive one this year.
Takeaway: we’ll know more in a few weeks, but it seems like unemployment insurance payments in 2020 may have skewed many Americans’ tax liabilities. In most states a UI recipient has a choice of whether to have taxes withheld or not. If they choose “not” – and many rationally would – a smaller/no tax refund may be the result. The $1,400 stimulus check will plug part of that shortfall, but only about half.