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The business situation (corporate profits; first quarter 1985 and 1984)

the BUSINESS SITUATION

REVISED (45-day) estimates show that real GNP increased at an annual rate of 1/2 percent in the first quarter of 1985. Preliminary (15-day) estimates had shown a 1 1/2-percent increase. Inflation, as measured by the increase in the GNP fixed-weighted price index, remained virtually unrevised at an annual rate of 4 1/2 percent.1 (For a note about the GNP implicit price deflator, see page 6.)

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.

The $2 1/2 billion downward revision in real GNP was due to partly offsetting changes in major components (table 1). Government purchases, change in business inventories, net exports, and nonresidential fixed investment were revised down. A $1 1/2 billion revision in government purchases was largely due to a revision in Commodity Credit Corporation transactions. Change in business inventories and net exports each were revised $1 billion. Within inventories, the revision was concentrated in manufacturing nondurables and in retail trade other than autos, and within net exports, imports of nonpetroleum goods were revised up more than exports of nonagricultural goods. A downward revision of $1/2 billion in nonresidential fixed investment was more than accounted for by producers' durable equipment. The upward revisions were in personal consumption expenditures (PCE) and residential fixed investment. A revision of $1 1/2 billion in PCE was more than accounted for by services and durable goods, and a revision of $1/2 billion in residential fixed investment was in multifamily structures.

The downward revision of the first-quarter estimates of real GNP reinforces the picture of slowing U.S. production described in the April "Business Situation.' In contrast to the small increase in real GNP, real gross domestic purchases, which includes imports and excludes exports so that it measures U.S. demand for goods and services wherever produced, increased 4 percent. The strength of U.S. demand was evident in a large first-quarter increase in PCE and a smaller one in business fixed and inventory investment. The greater strength in gross domestic purchases than in GNP indicates, however, that much of the increase in U.S. demand was met by imports.

Corporate Profits: First Quarter 1985 and Year 1984

Profits from current production-- profits with the inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)--increased $2 1/2 billion in the first quarter of 1985 to $294 billion. A $1/2 billion increase in domestic profits of financial corporations offset a decline in those of nonfinancial corporations, leaving domestic profits unchanged at $271 billion. Profits from the rest of the world increased $2 1/2 billion, to $23 1/2 billion.

In the fourth quarter, profits had recovered from the third quarter's $8 1/2 billion decline. Thus, profits have increased only $3 billion over the three quarters. This plateau reflects a slowdown in production; real GNP increased at an average rate of 2 percent in the three quarters--considerably slower than earlier in 1984 and in 1983.

Profits before tax (PBT) differ from profits from current production by two adjustments, the IVA and CCAdj. In the first quarter, PBT declined $4 1/2 billion, to $224 billion, following a $4 billion increase. Both adjustments were positive. The IVA--which converts tax-return-based inventory cost to that consistent with the NIPA's--increased $2 billion, from a negative $1 1/2 billion, to $1/2 billion, following a $1 1/2 billion decline. The CCAdj--which converts tax-return-based depreciation to that consistent with the NIPA's--increased $5 billion, to $69 1/2 billion, following a $6 billion increase. The CCAdj has been increasing $4 billion or more each quarter since the fourth quarter of 1982, largely reflecting the effects of shortened service lives for the depreciation of capital permitted under the Economic Recovery Tax Act (ERTA) of 1981.

PBT has three components--tax liability, dividends, and undistributed profits. Reflecting the course of PBT, tax liability declined $3 1/2 billion, to $84 billion, in the first quarter, following a $4 1/2 billion increase in the fourth. Dividends were up $1 1/2 billion, to $84 1/2 billion, in line with recent increases. Undistributed profits were down $2 1/2 billion, to $55 1/2 billion, the fourth consecutive decline.

Profits by industry.--Profits with IVA but without CCAdj is the variant of profits available by industry. This variant of domestic profits of nonfinancial industries declined $5 1/2 billion in the first quarter, to $174 billion, following a $5 1/2 billion increase.

The decline was concentrated in trade and durables manufacturing. Profits of both retailers and wholesalers contributed to the decline in trade profits, but those of retailers contributed more. Auto dealers, in turn, contributed the most to the decline in retail trade profits. For auto dealers, a more negative IVA, which reflected sharply increased auto prices, offset increased PBT, which reflected strong first-quarter sales.

Manufacturers of fabricated metal products and machinery (including computers, which are classified as nonelectrical machinery) contributed most of the decline in profits of manufacturers of durable goods. Manufacturers of transportation equipment experienced a larger loss in the first quarter than they had in the previous two.

Developments in 1984

Profits from current production-- profits with IVA and CCAdj--increased $60 1/2 billion, to $285 1/2 billion, in 1984, following a $66 billion increase in 1983. Domestic profits of nonfinancial corporations, up $63 1/2 billion, more than accounted for the increase; domestic profits of financial corporations and profits from the rest of the world declined slightly.

The increase in domestic profits of nonfinancial corporations reflected both a 9-percent jump in real product --last exceeded in 1959--and higher profits per unit of real product. The increase in unit profits can be viewed as the increase in unit price less that in unit labor and nonlabor costs; table 2 shows that unit profits were up because corporations' unit cost increased less than their unit price. In 1984, unit labor cost registered a slight increase and unit nonlabor costs--interest, capital consumption allowances with CCAdj, and indirect business taxes--were stable. Indirect business taxes changed little, and increased interest payments offset a decline in capital consumption allowances.

A second year of increase in unit labor cost smaller than that in unit price contrasts with the record of the past decade. In 1975, when the most recent recovery from a recession similar in depth and duration to that of 1982 began, the increase in unit labor cost was smaller than that in unit price. For the next 5 years, unit labor cost rose at rates equal to or greater than those of unit price. In 1981, following the 1980 recession, the rate of increase in unit labor cost was again less than that in unit price, but for only 1 year. However, a second year of smaller increase in unit nonlabor costs than in unit price is not unusual. Unit nonlabor costs rose more slowly than unit price in 1976-78, but they rose much more rapidly than unit price in 1975 and in 1980-82.

In 1984, PBT increased $32 1/2 billion, to $235 1/2 billion, following a $37 1/2 billion increase in 1983. The CCAdj increased $22 1/2 billion, to $55 1/2 billion, following a $30 billion increase. The IVA increased $5 1/2 billion, to a negative $5 1/2 billion, following a decline of $1 1/2 billion.

In 1984, profits from current production exceeded PBT by $50 billion (chart 1). The difference is more than accounted for by the larger amount of depreciation counted as an expense in the calculation of PBT. The depreciation, in turn, largely reflects the effects of the shortened service lives for the depreciation of capital permitted under ERTA. The contribution of the accelerated depreciation provisions of ERTA to the CCAdj have increased from $18 billion in 1982, the first full year of ERTA, to $52 billion in 1984 (table 3).

In the three-way division of PBT, corporate profits tax liability increased $14 billion in 1984, to $90 billion, following an increase of $15 billion. Dividends increased $7 1/2 billion in 1984, to $80 1/2 billion, following an increase of $3 1/2 billion. The ratio of dividends to PBT--the payout ratio-- was 34 percent in 1984, 2 percentage points less than in 1983, but substantially above the 23 percent average for the 1970's. The high ratios in 1983-84 reflect the lower PBT because of the accelerated depreciation provisions of ERTA. Comparison of dividends with profits from current production provides a relationship unaffected by ERTA. The ratio of dividends to profits from current production was 28 percent in 1984, close to the 27 percent average of the 1970's. Undistributed profits were up $11 billion, to $65 1/2 billion, following an increase of $19 billion.

Profits by industry.--Profits with IVA but without CCAdj--the variant of profits available by industry--increased $38 billion in 1984, to $230 billion, following an increase of $36 billion. The broad picture is the same as that displayed by profits from current production. Domestic profits of nonfinancial corporations more than accounted for the increase, and domestic profits of financial corporations and profits from the rest of the world declined.

Profits from the rest of the world declined $2 billion, to $23 billion, following an increase of $2 1/2 billion. Largely because of faster economic growth in the United States than abroad, an increase in earnings on direct investment in the United States, an outflow of profits, more than offset an increase in the corresponding inflow from U.S. direct investment abroad. Earnings on European investments in petroleum and manufacturing and on Japanese investment in wholesale trade contributed the most to the increased outflow.

Domestic profits of financial corporations were down $2 billion, to $28 billion, following an increase of $10 billion. The decline reflects lower profits of nonlife insurance companies and of savings and loan associations. Nonlife insurance companies suffered casualty losses that offset investment earnings. Savings and loan associations faced faster growth in their cost of funds, which they raise in a more competitive environment following the 1983 deregulation, than in yields on their portfolios, which are burdened with long-term mortgages.

Domestic profits of nonfinancial corporations were up $41 1/2 billion, to $179 billion, following an increase of $23 1/2 billion. The increase in domestic profits of nonfinancial corporations was widespread among industries. In 1983, declines had appeared in the profits of construction, communication, and several manufacturing industries: food products, petroleum products, transportation equipment, electric and electronic equipment, and machinery, except electrical. In 1984, only profits of manufacturers of petroleum products declined.

Manufacturers contributed a more than proportionate share of the increase in profits; their profits accounted for about one-half of the increase in 1984, although they contributed only about one-third of the 1984 total profits by industry. In 1983, they had contributed a less than proportionate share of the increase in profits by industry. Most of the increase in 1984 was, in turn, in profits of manufacturers of durable goods, where increases were widespread. In 1983, also, most of the increase had been in profits of manufacturers of durable goods, but was concentrated in motor vehicles. Thus, the second year of the recovery showed a broader improvement in profits of manufacturers of durable goods. Even manufacturers of primary metals products swung from losses to profits, for the first time since 1981. Only manufacturers of transportation equipment continued to register losses.

Trade profits accounted for about one-third of the 1984 increase, up from one-fifth in 1983, although trade contributed only one-fifth of the 1984 total profits. The increase was concentrated in profits of wholesalers, whose product increased 13 percent in 1984, partly due to the sharply increased value of merchandise exports. Profits of retailers were up moderately.

Government Sector

The fiscal position of the government sector in the national income and product accounts changed substantially in the first quarter, as the combined deficit of the Federal Government and of the State and local governments declined $35 billion to $107 billion. The dominant factor was a $37 billion decline in the Federal deficit; the State and local surplus declined $2 billion.

The Federal sector.--The Federal Government deficit declined to $161 billion, as receipts increased more than expenditures. The large decline in the deficit was the result of a delay in the payment of personal income tax refunds; see the "Current developments' section, which follows. Excluding the impact of this delay--estimated to be about $26 billion--the deficit declined $10 1/2 billion to $187 billion, compared with $161 billion of a year earlier.

Receipts increased $47 1/2 billion, compared with $15 1/2 billion in the fourth quarter. The acceleration was largely accounted for by personal tax and nontax receipts, which increased $33 billion, compared with $8 1/2 billion in the fourth quarter. The large increase in personal taxes was due to the delay in the payment of income tax refunds. As a result of this delay, refunds--which are deducted when calculating personal taxes--were unusually small. Excluding the impact of the delay, personal taxes increased $7 billion. Contributions for social insurance increased $16 1/2 billion, compared with $4 billion in the fourth quarter. The larger increase in contributions reflected several special factors: (1) increases in the Social Security tax rate from 13.7 percent to 14.1 percent and in the tax base from $37,800 to $39,600 contributed $6 billion and $1 1/2 billion, respectively; (2) an increase in the Federal and State average tax rates for unemployment insurance contributed $1 1/2 billion; and (3) an increase in the supplementary medical insurance premium from $14.60 to $15.50 per month contributed $1/2 billion. In the other categories of receipts, indirect business tax and nontax accruals increased $1/2 billion, refelcting an increase in customs duties, and corporate profits tax accruals declined $2 1/2 billion, following the course of corporate profits.

Expenditures increased $10 1/2 billion, compared with $33 billion in the fourth quarter, when all expenditure categories except transfer payments to persons recorded strong gains. In the first quarter, transfer payments to persons recorded a strong increase and all other categories either increased considerably less than in the fourth quarter or declined. Two special factors accounted for most of a $16 billion increase in transfer payments to persons: (1) cost-of-living increases for various benefits, including Social Security benefits ($6 billion) and civilian and military retirement benefits ($1 billion and $1/2 billion, respectively), contributed $8 1/2 billion; and (2) military retirement benefits (excluding the cost-of-living increase), reflecting the shift in the benefit payment from the last of the month to the first of the following month, effective December 31, 1984, contributed $5 1/2 billion. Excluding these factors, transfer payments increased $2 billion.

The only other expenditure categories that recorded increases were national defense purchases of goods and services and net interest paid ($2 billion each). In national defense purchases, a $2 1/2 billion increase due to a 3 1/2-percent civilian and a 4-percent military pay raise effective January 1 more than offset a $1/2 billion decline in all other purchases. A $9 1/2 billion decline in all other expenditure categories combined included $4 1/2 billion in transfer payments to foreigners; these transfers had included a large payment to Israel in the fourth quarter. Nondefense purchases of goods and services declined $1 billion; declines in the purchases of agricultural commodities by the Commodity Credit Corporation and of oil purchases for the strategic petroleum reserve ($1 billion each) were partly offset by an increase due to the pay raise ($1 billion).

Cyclically adjusted surplus or deficit. --When measured using cyclical adjustments based on middle-expansions trend GNP, the Federal fiscal position moved from a deficit of $203 billion in the fourth quarter to a deficit of $160 billion in the first (see table 3 on page 13). The cyclically adjusted deficit as a percentage of middle-expansion trend GNP decreased from 5.4 percent in the fourth quarter to 4.2 percent in the first.

The State and local sector.--The State and local government surplus declined $2 billion to $53 1/2 billion, as expenditures increased more than receipts. A $2 1/2 billion decline in the surplus of "other' funds--that is, other than social insurance--was partly offset by a $1/2 billion increase in the surplus of the social insurance funds.

Receipts increased $6 billion, compared with $15 billion in the fourth quarter, when Federal grants-in-aid recorded a strong increase. Indirect business tax and nontax accruals increased $5 billion in the first quarter; sales taxes and property taxes each increased $2 billion. Personal tax and nontax receipts increased $3 billion, and contributions for social insurance increased $1 billion. Partly offsetting these increases were declines in Federal grants-in-aid ($2 billion) and corporate profits tax accruals ($1 billion).

Expenditures increased $8 billion, compared with $7 billion in the fourth quarter. Purchases of goods and services accounted for most of the increase; all other expenditures, on balance, increased $1 1/2 billion. Within purchases, compensation increased $5 1/2 billion, construction declined $1 1/2 billion, and all other purchases increased $3 1/2 billion. The decline in construction was in highways. Since mid-1984, highway construction has dominated the change in construction purchases. In the second and third quarters of 1984, highway construction recorded increases that averaged $2 1/2 billion and accounted for about 80 percent of the increase in the total; declines since then accounted for about 80 percent of the decline in the total. (See the "Current developments' section, which follows.)

Current developments.--As mentioned earlier, the large decline in the Federal Government deficit in the first quarter was mainly due to a delay in the payment of personal income tax refunds, which resulted in a very high level of personal tax and nontax receipts. BEA has estimated that the delay reduced refunds about $29 billion in February and $49 1/2 billion in March; for the quarter, the impact was $26 billion. The delay in refund payments--which was largely due to computer processing problems at the Internal Revenue Service regional offices--is being made up in the second quarter. The makeup will result in an usually low level of personal taxes in the second quarter and a rebound in the deficit. Refunds were about $16 billion higher than normal in April and are expected to be substantially higher in May.

National defense purchases should also rebound strongly in the second quarter. Two B-1 bombers may be delivered this quarter--1 regularly scheduled and 1 postponed from the first quarter; those deliveries, coupled with a rebound in other purchases, should result in a strong gain. Grants-in-aid to State and local governments should also rebound, reflecting increased highway grants. New legislation governing the highway trust fund was finally approved in March-- a continuing resolution had been in place for over a year; funds should begin to flow to State and local governments in this quarter. Although highway construction should rebound in the second quarter, that rebound will not be the direct result of the availability of these funds. State and local governments have been finding other short-term ways to finance this construction, and these grant funds will initially be used to pay off this other financing.

Table: 1.--Revisions in Selected Component Series of the NIPA's, First Quarter of 1985

Table: 2.--Product and Unit Prices, Costs, and Profits of Domestic Nonfinancial Corporations: Percent Change From Preceding Year

Table: 3.--Domestic Profits

Photo: CHART 1 Composition of Domestic Corporate Profits From Current Production
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Publication:Survey of Current Business
Date:May 1, 1985
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