Economic Recovery Should Mean Higher Tax Collections

In a ‘normal’ recovery, one would expect tax collections at every level to increase. If folks are spending money, sales tax revenues should increase. If economic growth is really occurring, other tax revenues should be increasing - but that’s not what is happening.

To find evidence of declining tax revenues, one needs to look at a level of government lower than the federal level. State governments for example, need to operate in balance – spending only what is received in the form of tax revenues. While there are many examples of states whose budgets are in trouble, there are a couple of states that have recently made headlines – Illinois and California.

An article published in “The Beacon News” part of the Sun Times media group on January 4, 2010 titled “School Bills are Due but State Won’t Pay” describes just one of many areas affected by the State of Illinois’ inability to pay its bills.

This from the article:

Say the words out loud to get a feel for the size of it: Forty-five million, two hundred and six thousand, six hundred and fifty-four dollars, and sixty-one cents.

That’s how much the state is behind in payments to your local schools.

When the quarterly payments came due at the end of the year, the state again missed its categorical and grant payments to all 871 Illinois school districts.

This money is supposed to fund projects like school buses, special education, reading programs and early childhood development. But the money’s not coming, instead getting added bill by bill to an already $4.5 billion IOU the state has for services from schools to homeless shelters.

“Billion. With a B.,” said comptroller spokesman Carol Knowles. “The bill backlog is just nearly beyond comprehension.”

But the same state that’s no longer paying for these programs legally requires them. So to cover the missing money, school districts must either dig into reserves or, where there are no reserves, cut into other areas: repairs, programs not required by law, teachers.

Unlike the usual budget bellyaching when political pressure can make money appear, this time is different, said state Rep. Linda Chapa LaVia, D-Aurora. There is no money.

“This is not a false alarm. This is not someone pulling a fire drill. This is a fire,” Chapa LaVia said.

The Otwego school district has not collected over $6.8 million that it was expecting. The West Aurura district has not been paid over $6 million that was expected. These are just 2 examples.

While many school districts in the State are looking to cut teaching staff in order to balance their budgets, some are unable to do so due to minimum student to teacher ratios mandated by contracts with teachers unions. As a result, some districts are selling tax warrants, essentially getting loans on revenues that they’re expecting later this year from property tax revenues.

A “New York Times” article published on January 8, 2010 said this about California’s budget woes:

Gov. Arnold Schwarzenegger took his first shot at closing California’s impending $20 billion budget gap on Friday, proposing large-scale pay cuts for state workers, the elimination of several social service programs and a plan to press the federal government for more money.

The suggested cuts — which were met with resistance from lawmakers, with whom he must negotiate a final budget — come on the heels of tens of billions of dollars in cuts and tax increases over the last budget cycle.

“I know many of these cuts are painful,” Mr. Schwarzenegger said at a news conference in Sacramento. “Believe me, these are the hardest decisions a governor has to make. Yet there is simply no conceivable way to avoid more cuts and more pain.”

Much of the state’s money must be spent on mandates required by Washington and state ballot initiatives, and the economy continues to be sluggish. As a result, the governor, short on solutions, took aim at entire programs and wholesale spending areas, rather than seizing on across-the-board trims, the usual method of cutting.

For instance, Mr. Schwarzenegger chose not to cut financing for public universities, but has proposed eliminating the state’s $1 billion welfare program for families with children, ending a $126 million health insurance program for children, reducing the state’s Medicaid eligibility to the minimum to save over $500 million, and ending the state’s network of subsidized home health care providers for the poor.

Bottom Line: If the economic recovery that many analysts say is underway is real, tax revenues will have to increase. So far this hasn’t happened.

My view is that the equity markets will wake up to this fact this year, particularly if federal stimulus is removed from the economy early this year as planned. I am of the opinion that investors may want to act defensively by using portfolios with exit strategies* that would allow an investor to exit an investment shortly after a downtrend begins. At this point with January looking like it may finish the month slightly negative, we could be only one month away from a trend change confirmation.

Stay tuned.

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* Exit strategies are employed to lock in a profit or prevent a significant loss by determining at what point an investment will be sold. No exit strategy will be 100% accurate. Having an exit strategy does not guarantee a profit and/or guarantee against loss. This information is education in nature and, therefore, is not intended to constitute investment advice and should not be interpreted as a recommendation to purchase, sell or hold a particular security. Prior to making any investment decision, the services of an appropriate professional should be sought as investment related recommendations are dependent upon the personal situation of each individual investor. Investing in market related securities involves a risk of principal loss