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The business situation, first quarter 1986.

the BUSINESS SITUATION REVISED (45-day) estimates show that real GNP increased at an annual rate of 3-1/2 percent in the first quarter of 1986. Preliminary (15-day) estimates had shown a 3-percent increase. The increase in the GNP fixed-weighted price index, 2-1/2 percent at an annual rate, was revised little (table 1).

The $4-1/2 billion upward revision in real GNP was more than accounted for by revisions in business inventory investment and in government purchases of goods and services; these revisions were partly offset by a sizable downward revision in net exports. The revision in net exports reflected the use of new seasonal adjustment factors as well as the revised and additional source data usually incorporated in the 45-day estimates. New seasonal factors for other GNP components will be introduced at the time of the annual revision of the national income and product accounts in July. For net exports, new seasonals were introduced earlier for consistency with the revised U.S. international transactions accounts to be released in June. The new seasonals used to estimate the first-quarter change for merchandise trade for the 45-day estimates are preliminary and subject to revision when the 75-day estimates are released next month.

The 45-day estimates include a preliminary estimate of corporate profits for the quarter that fills out the "income side" of the national income and product account. (First-quarter developments in corporate profits are described in the following section of the "Business Situation.") Current-dollar national income--a measure of net production at factor, cost--increased $45-1/2 billion, or 5-1/2 percent, in the first quarter, about the same percentage increase as in the fourth. In contrast, current-dollar GNP--a measure of gross production at market prices--increased $62 billion, or 6-1/2 percent, in the first quarter, considerably more than in the fourth. The differences in the movements of these two measures can largely be traced to developments in nonfactor cost items, particularly indirect business taxes and the current surplus of government enterprises less subsidies (table 2).

Indirect business taxes increased $8-1/2 billion in the first quarter, following a $3 billion increase in the fourth. In Federal taxes, a major U.S. petroleum corporation paid a substantial fine--$8-1/2 billion (annual rate)--in the first quarter for past violations of Federal oil price regulations. Also, windfall profit taxes declined $3 billion after little change, reflecting the sharp drop in oil prices. In State and local taxes, sales taxes resumed an uptrend after a pause in the fourth quarter.

The current surplus of government enterprises less subsidies increased $5 billion, following a $9 billion drop in the fourth quarter. Changes in both the current surplus and subsidies were largely attributable to the Commodity Credit Corporation (CCC). The current surplus of the CCC--the difference between revenues and operating expenses, plus an adjustment for the difference between CCC transaction prices and market prices--increased $3 billion in the first quarter, following a $4 billion decline in the fourth. Subsidies paid by the CCC--direct payments to farmers--declined $1-1/2 billion, following a $6 billion increase.

Addition of the above two items, along with business transfer payments, to national income yields charges against net national product. (It should be noted that several of the developments in the two items have counterentries in components of national income: The fine for violations of price regulations reduces corporate profits, and windfall profit taxes and farm subsidies affect corporate profits and proprietors' income. Thus, these development do not affect charges against net national product.) Charges against net national product--a measure of net production at market prices--increased $59-1/2 billion, or 6-1/2 percent, in the first quarter, considerably more than in the fourth. Capital consumption allowances with capital consumption adjustment, which increased $3-1/2 billion after a $6-1/2 billion after a $6-1/2 increase, is then added to charges against net national product to yield an "income side" measure of gross production at market prices, that is, charges against GNP.

Charges against GNP and GNP differ by the statistical discrepancy that arises because the income and product sides of the account are estimated independently. The discrepancy declined slightly in the past two quarters to $1-1/2 billion in the first quarter.

Corporate Profits

Profits from current production--profits before tax with inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)--increased $11 billion in the first quarter of 1986, following a $6 billion decline in the fourth quarter of 1985.

Domestic profits of nonfinancial corporations increased $7 billion in the first quarter, following a decline of $11-1/2 billion in the fourth, reflecting increases both in real gross corporate product and in profits per unit of product. The increase in unit profits resulted from a larger increase in unit price than in unit cost.

Domestic profits of financial corporations increased $2-1/2 billion in the fourth quarter, following an increase of $1 billion, and profits from the rest of the world increased $1-1/2 billion, following an increase of $4-1/2 billion.

Profits before tax.--Profits before tax (PBT) declined $16 billion in the first quarter, following an increase of $5-1/2 billion in the fourth. The contrast between the increase in profits from current production and the decline in PBT is due to the CCAdj, which declined $1/2 billion, and to the IVA, which increased $27-1/2 billion. Both of these adjustments are reflected in the current production measure but not in PBT.

The CCAdj is the difference between depreciation based largely on tax accounting, on the one hand, and economic depreciation as defined by BEA, on the other. The IVA removes the capital-gains-like element from profits when inventory prices increase; likewise, it removes the capital-loss-like element when inventory prices decline. In the first quarter, inventory prices declined substantially, following increases in the fourth quarter. For example, the Producer Price Index, a major source for estimating the IVA, declined 5-1/2 percent (annual rate) in the first quarter, following a 5-percent increase in the fourth. As a result of the drop in inventory prices, the IVA swung to $17-1/2 billion from negative $10 billion.

Profits with IVA but without CCAdj.--The measure of profits available by industry increased $11-1/2 billion, following a decline of $9-1/2 billion. A $7 billion increase in the profits of nonfinancial corporations was more than accounted for by trade and communications; manufacturing profits declined.

In both wholesale and retail trade, profits increased with increasing constant-dollar sales. In communications, profits increased very sharply, following a record decline of $2 billion; on average over the two quarters, profits were in line with profits over the preceding year and a half.

In manufacturing, profits declined for the second quarter in a row. The decline was more than accounted for by a huge drop in petroleum profits, although profits of nonelectric machinery manufacturers also declined substantially. Most ($8-1/2 billion at an annual rate) of the drop in petroleum profits reflected a fine paid to the U.S. Department of Energy by a major corporation in accordance with a Federal court ruling that had found that the corporation overcharged customers for crude oil during 1975-80 in violation of Federal oil price regulations. Profits of petroleum manufacturers were also depressed in the first quarter by the sharp drop in crude oil prices because corporations in this industry also are heavily engaged in the extraction of domestic crude. In non-petroleum manufacturing, a decline in profits in nonelectric machinery (which includes computer manufacturing) and a very large increase in profits of printing and publishing reflected changes in constant-dollar sales by the industries. In chemials, profits rebounded after a record $3 billion decline; the industry benefited from the drop in crude oil prices, which lowered the cost of petrochemical feedstocks.

More than half of the $2-1/2 billion increase in profits of financial corporations was accounted for by reduced losses of insurance carriers, probably due to an upturn in property-casualty rates. Federal Reserve profits also increased as an increase in holdings of Federal debt instruments more than offset a decline in interest rates.

Government Sector

The fiscal position of the government sector in the national income and product accounts (NIPA's) improved in the first quarter of 1986, as the combined deficit of the Federal Government and of State and local governments declined $22 billion (table 3). The improvement occurred at both levels of government, but was largely due to a decline in the Federal deficit.

The Federal sector.--The Federal Government deficit declined $16-1/2 billion in the first quarter to $210-1/2 billion, as expenditures declined more than receipts. (Concurrent declines in Federal receipts and expenditures have occured only once before in the past 30 years--in the third quarter of 1970.)

Receipts declined $1/2 billion after a $13 billion increase in the fourth quarter. This swing was due to several special factors that caused sizable declines in two receipt categories and sizable increases in the other two. Corporate profits tax accruals declined $7 billion, and personal tax and nontax receipts declined $6 billion. The decline in corporate taxes was due to a decline in the income on which they are accrued; profits before tax is the NIPA measure of profits that most closely approximates the tax base. The decline in personal taxes, in contrast, was due to legislative changes: The indexing provisions of the Economic Recovery Tax Act of 1981 reduced income taxes $7-1/2 billion. Contributions for social insurance increased $7-1/2 billion, and indirect business tax and nontax accruals increased $5 billion. The increase in contributions included over $6 billion for increases in Social Security tax rates ($4 billion) and in the taxable wage base ($2-1/2 billion), effective January 1,1986. The increase in indirect business taxes was the net result of n $8 billion increase in nontaxes and $3 billion decline in windfall profit taxes. The increase in nontaxes was due to a fine ($8-1/2 billion at an annual rate) paid by a major petroleum corporation as a result of a Supreme Court ruling on pricing and allocation violations under the Emergency Petroleum Allocation Act of 1973. The decline in windfall profit taxes reflects the large declines that have occurred in oil prices.

Expenditures declined $17 billion after a $38-1/2 billion increase in the fourth quarter. This swing was largely accounted for by the effect of programs of the Commodity Credit Corporation (CCC) on nondefense purchases of goods and services and on subsidies less the current surplus of government enterprises.

Nondefense purchases declined $24 billion after an increase of $17-1/2 billion in the fourth quarter. The purchases of agricultural commodities by the CCC accounted for almost all of the first-quarter decline and all of the fourth-quarter increase. In the fourth quarter, farmers placed record amounts of crops with the CCC under the commodity loan program; in the first quarter, they placed a much smaller, albeit still substantial amount. These large placements reflect the fact that prices for major crops continued to be low enough relative to the CCC loan rate to give farmers an incentive to place crops under loan--in effect, to sell them to the CCC.

Subsidies less current surplus--the other expenditure category affected by CCC programs--declined $5 billion after a $10 billion increase in the fourth quarter. The CCC deficit, which had increased $4 billion in the fourth quarter, declined $3 billion in the first. The remainder of the swing was accounted for by agricultural subsidies: They had increased $6 billion in the fourth quarter--mainly for deficiency payments for the 1985 wheat crop--and declined $1-1/2 billion in the first.

Although programs of the CCC largely accounted for the swing in expenditures, there were also swings from increase to decline in national defense purchases of goods and services and in transfer payments to foreigners. These were offset, however, by larger increases in two other expenditure categories.

National defense purchases declined $3 billion after a $2 billion increase in the fourth quarter. As was pointed out in the April "Business Situation," it is likely that the first-quarter decline reflected to some extent the reductions made to comply with the Balanced Budget and Emergency Deficit Control Act of 1985, better known as the Gramm-Rudman-Hollings Act. However, large quarter-to-quarter fluctuations typical of defense spending make it difficult to identify how much of the decline can be attributed to the act.

Transfer payments to foreigners declined $5-1/2 billion after a $1/2 billion increase in the fourth quarter. The fourth-quarter level of these transfer payments had been boosted by payment of the entire amount of the fiscal year 1986 economic support assistance ($5 billion at an annual rate) to Israel. In the first quarter, Israel returned 4.3 percent of the payment due to Gramm-Rudman-Hollings.

Among other expenditures, transfer payments to persons and grants-in-aid to State and local governments increased $9 billion each. The increase in transfer payments included a number of cost-of-living increases, the largest of which was a 3.1-percent increase in Social Security benefits ($5-1/2 billion). The increase in grants-in-aid included a passthrough of the fine mentioned earlier to State and local governments to finance energy conservation programs and energy assistance to low-income persons. Net interest paid increased $2 billion, compared with $6 billion in the fourth quarter; the deceleration was largely due to lower interest rates.

Cyclically adjusted surplus or deficit.--When measured using a cyclical adjustments based on middle-expansion trend GNP, the Federal fiscal position moved from a deficit of $229 billion in the fourth quarter to a deficit of $217 billion in the first (see table 2 on page 19). The cyclically adjusted deficit as a percentage of middle-expansion trend GNP decreased from 5.7 percent of GNP in the fourth quarter to 5.3 percent in the first.

The State and local sector.--The State and local government sector surplus increased $6 billion in the first quarter to $64-1/2 billion, as receipts increased more than expenditures. An increase in the other funds surplus accounted for 80 percent of the total increase.

Receipts increased $13-1/2 billion, compared with $7-1/2 billion in the fourth quarter. The acceleration was more than accounted for by grants-in-aid, reflecting the passthrough of the fine mentioned earlier. Personal tax and nontax receipts increased less than in the fourth quarter. Tax cuts in 1985, in several States--including Indiana, Michigan, and Oregon--had not always been fully reflected in 1985 withholding changes and, as a result, net final settlements in the first quarter were reduced about $1 billion. In addition, 1986 tax cuts in Massachusetts, Pennsylvania, and Wisconsin reduced income taxes by about $1 billion.

Expenditures increased $7-1/2 billion, compared with $5-1/2 billion in the fourth quarter. The acceleration was largely accounted for by purchases of goods and services; they increased $6-1/2 billion in the first quarter, compared with $5 billion in the fourth. The stronger pace of purchases was more than accounted for by purchases of structures. Recently, these purchases have been the dominant factor in the movement of total purchases. In 1985, changes ranged from an increase of $7 billion in the second quarter to a decline of $4 billion in the fourth. The fourt-quarter decline was largely accounted for by highway construction. In the first quarter, purchases of structures increased $1 billion; although highway construction continued to decline, most other types increased. Among other types of purchases, a $2 billion drop in purchaess of nondurable goods was offset by increased in purchases of durable goods and of services. The decline in non-durable goods was more than accounted for by a drop in purchases of petroleum products, reflecting declining prices.

Second-quarter outlook.--Federal government receipts will rebound in the second quarter despite a continued decline in windfall profit taxes and the absence of the fine. The strength of an expected rebound in corporate profits tax accruals will determine how strongly receipts will increase.

Expenditures will probably be unchanged in the second quarter. Both national defense and nondefense purchases will decline, in part due to Gramm-Rudman-Hollings. CCC purchases will decline further; the extent will depend on various payment-in-kind provisions of the Food Security Act of 1985 (see the April SURVEY OF CURRENT BUSINESS for a discussion of the act). If extensive use of these provisions occurs in the second quarter, CCC purchases could swing from an expected position of small acquisition to one of rather large disposition. (The use of payments in kind will not affect total expenditures because they are offset in agricultural subsidies.) Transfer payments to persons will increase but at a slower pace than in the first quarter. Grants-in-aid will decline; a $3-1/2 billion increase due to a one-time payment from the resolution of a dispute over Outer Continental Shelf funds will be more than offset by a decline due to the fine passthrough and the effects of Gramm-Rudman-Hollings. Net interest paid and subsidies less current surplus will increase, the latter reflecting a very large April payment of CCC deficiency subsidies. The deficit will decline somewhat--the extent largely dependent on the strength of receipts.

At the State and local level, receipts will decline due to the sharp drop in grants-in-aid mentioned above. Personal taxes will reflect additional tax cuts. Expenditures will probably increase at a pace similar to that in the first quarter. However, if highway construction rebounds and other construction records even modest growth, the increase could be larger. In either case, the other funds fiscal position will swing to deficit.
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Publication:Survey of Current Business
Date:May 1, 1986
Words:2908
Previous Article:County and metropolitan area personal income, 1982-84.
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