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The business situation.


REVISED (45-day) estimates show that real GNP increased at an annual rate of 2 percent in the second quarter of 1985--a little more than shown by the preliminary estimates (table 1). An upward revision in inventory investment more than offset a downward revision in final sales. Within final sales, fixed investment (in residential and nonresidential structures) and government purchases were revised down; net exports and personal consumption expenditures were revised up. At 4 percent, the annual rate of increase in prices, as measured by the GNP fixed-weighted price index, was revised little. Overall, the economic picture presented in the July "Business Situation' did not change much.

Corporate profits

Profits from current production-- profits with the inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)--increased $5 billion, to $297 1/2 billion, in the second quarter, following an increase of $1/2 billion in the first quarter.1

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.

Domestic profits of financial corporations more than accounted for the increase; domestic profits of nonfinancial corporations declined $1/2 billion, and profits from the rest of the world increased $1/2 billion.

Profits before tax (PBT) differ from profits from current production by two adjustments, the IVA and CCAdj. In the second quarter, PBT declined $1 billion, to $221 billion, following a decline of $6 1/2 billion. The IVA-- which converts tax-return-based inventory cost to that consistent with the NIPA's--increased $1/2 billion, to $1 1/2 billion, following a $2 1/2 billion increase. The CCAdj--which converts tax-return-based depreciation to that consistent with the NIPA's--increased $5 1/2 billion, to $74 1/2 billion. The increase was the tenth consecutive one of $4 billion or more. The continued growth in the CCAdj during this period mainly reflects the effects of accelerated depreciation for recently acquired assets, permitted by the Economic Recovery Tax Act of 1981.

PBT has three components--tax liability, dividends, and undistributed profits. Reflecting the small decline in PBT, tax liability declined $1/2 billion, to $84 1/2 billion in the second quarter, following a decline of $2 1/2 billion. Dividends were up $1 billion, slightly less than increases in recent quarters. Undistributed profits were down for the fifth consecutive quarter.

However, with the IVA and CCAdj, undistributed profits were up $4 1/2 billion, to $127 billion, following a $1 1/2 billion increase. Capital consumption allowances (mainly depreciation) with CCAdj, were up $4 1/2 billion, to $262 billion, following three consecutive increases of the same size. The sum of adjusted undistributed profits and capital consumption allowances, or current-production cash flow, has increased for 10 consecutive quarters.

Profits by industry.--Because the CCAdj is not available by industry, profits with the IVA but without the CCAdj is the measure of profits used to get a view of profits by industry. In contrast to the $5 billion increase in profits from current production in the second quarter, the measure without the CCAdj declined $1/2 billion, to $222 1/2 billion. In the first quarter, profits from current production had increased $1/2 billion, and the measure without CCAdj had declined $4 billion (table 2). Thus, in recent quarters, the use of the measure without CCAdj as a proxy for profits from current production warrants special caution.

The caution relates to the domestic profits, and largely to those of nonfinancial corporations; most of the CCAdj--and its increases of more than $4 billion in recent quarters-- would apply to the profits of nonfinancial corporations. For these corporations, domestic profits with the IVA but without the CCAdj declined $6 billion in the second quarter, following a decline of $4 1/2 billion. The second-quarter decline was more than accounted for by manufacturing; an increase in trade was partly offset by a decline in other nonmanufacturing.

For financial corporations, domestic profits with IVA and without CCAdj increased $5 billion, to $33 billion, following an increase of $1 billion. These increases were about the same as those in profits from current production. The second-quarter increase reflected sharp improvement in the profits of saving and loan associations, whose costs of raising funds have gone down with interest rates.

Government sector

The fiscal position of the government sector in the national income and product accounts (NIPA's) deteriorated significantly in the second quarter, as the combined deficit of the Federal Government and of State and local governments increased $49 billion. The deterioration was largely due to an increase in the Federal deficit; the State and local surplus declined $3 billion. At $160 billion, the combined deficit was also considerably higher than a year earlier. The increase over a year earlier was largely due to a $47 billion increase in the Federal deficit.

These unusually large increases in the Federal deficit are temporary and are mainly the result of a delay in the payment of personal tax refunds in the first quarter and a catchup in the second quarter. This delay and catchup --which amounted to $27 1/2 billion --has caused unusual movements in the level of personal tax and nontax receipts (from which refunds are subtracted) and the deficit.

The Federal sector.--The Federal Government deficit increased $45 1/2 billion in the second quarter to $211 billion, as receipts declined and expenditures increased.

Receipts declined $36 1/2 billion, compared with a $49 1/2 billion increase in the first quarter. Personal taxes largely accounted for this shift; they declined $44 billion in the second quarter after an increase of $34 1/2 billion, reflecting the payment pattern of refunds.

Excluding the effect of refunds, receipts increased $18 1/2 billion, compared with $22 billion in the first quarter. Indirect business tax and nontax accruals increased $4 billion, the net result of a $5 billion increase in nontaxes and a $1 billion decline in customs duties. The large increase in nontaxes reflected a one-time fee levied on the nuclear power industry for existing stocks of nuclear waste, which will be disposed of by the Federal Government. Contributions for social insurance increased $3 1/2 billion, and corporate profits tax accruals declined $1/2 billion.

Expenditures increased $9 billion, compared with $16 1/2 billion in the first quarter, when cost-of-living adjustments resulted in a large increase in transfer payments to persons. National defense purchases of goods and services increased $6 1/2 billion; the increase was concentrated in durable goods and in services other than compensation (see table 2 on page 10). Net interest paid increased $4 1/2 billion, and grants-in-aid to State and local governments increased $3 billion. The increase in grants was accounted for by highways; smaller increases in grants for public assistance ($1 billion) and for waste treatment ($1/2 billion) were offset by a decline in grants for education. Partly offsetting these increases were declines of $3 billion each in nondefense purchases and transfer payments and $1/2 billion in subsidies less the current surplus of government enterprises. The decline in nondefense purchases was accounted for by the Commodity Credit Corporation (CCC). The decline in transfer payments was shared equally between transfer payments to persons and to foreigners. In the former, the decline was more than accounted for by unemployment insurance benefits; in the latter, the decline was in foreign assistance programs. The decline in subsidies less current surplus was the net result of a $1 billion decline in each of the surpluses of the CCC and the Postal Service and a $1 1/2 billion increase in subsidy payments to farmers.

Cyclically adjusted surplus or deficit. --When measured using cyclical adjustments based on middle-expansion trend GNP, the Federal fiscal position moved from a deficit of $163 billion in the first quarter to a deficit of $207 billion in the second (see table 3 on page 11). The cyclically adjusted deficit as a percentage of middle-expansion trend GNP increased from 4.2 percent in the first quarter to 5.3 percent in the second.

The State and local sector.--The State and local government surplus declined $3 billion, as expenditures increased more than receipts. A $1 billion increase in the surplus of social insurance funds only partly offset a $4 billion decline in the surplus of other funds.

Receipts increased $12 billion, compared with $6 billion in the first quarter; the acceleration was largely accounted for by grants-in-aid, which increased after a $2 billion decline in the first quarter. Indirect business tax and nontax accruals increased $5 1/2 billion; sales taxes increased $3 billion, and property taxes increased $2 billion. Personal tax and nontax receipts increased $3 billion, and contributions for social insurance increased $1 billion. Corporate profits tax accruals declined slightly.

Expenditures increased $15 1/2 billion, compared with $8 billion in the first quarter. The acceleration was accounted for by purchases of goods and services; they increased $14 1/2 billion in the second quarter, compared with $7 billion in the first. Transfer payments to persons accounted for the remainder of the increase in both quarters. Within purchases, construction increased $6 billion, compensation of employees increased $5 billion, and all other purchases increased $3 1/2 billion. The increase in construction, as well as a first-quarter decline of $1 1/2 billion, was concentrated in highway construction.

Current developments.--Federal Government receipts will rebound in the third quarter when the payment of personal tax refunds returns to a normal pattern. This factor alone will add $27 1/2 billion to the level of receipts in the third quarter. It now appears that fiscal year 1985 receipts on the NIPA basis will fall short of the April translation of the unified budget by $10 billion to $15 billion. (See "Federal Budget Developments' in the April SURVEY OF CURRENT BUSINESS for a discussion of the April transaltion.) The bulk of the shortfall will be in corporate profits tax accruals. Expenditures will probably increase in the third quarter at about the same pace as in the second, although the pace of CCC expenditures is a major element of uncertainty. National defense purchases will probably have another strong quarter--but still show a shortfall for the fiscal year-- as could grants-in-aid and net interest paid. Subsidies less current surplus will probably show a considerable decline in the third quarter, as subsidies to farmers drop. In total, expenditures will fall short of the April translation estimate for fiscal year 1985 by $4 billion to $6 billion. These estimates would put the fiscal year 1985 deficit at about $190 billion on the NIPA basis.

At the State and local level, receipts in the third quarter will probably not increase as much as in the second because tax changes will reduce receipts about $1 billion. These changes include both new legislative actions and the removal of temporary increases enacted 2 years ago. Expenditures also will probably not increase as much in the second quarter, because construction is not expected to maintain the second-quarter pace. The other funds surplus will probably decline again.

Federal Budget Developments

Since the administration submitted the fiscal year 1986 budget in early February, budget policy has been the dominant issue in Congress. For 6 months, Congress has worked to piece together a budget that would be acceptable to both Houses of Congress and to the administration. On August 1, Congress finally adopted the first concurrent resolution on the budget for fiscal year 1986. The resolution calls for a $57.5 billion deficit reduction that would be achieved by increasing receipts $3 billion and reducing outlays $54.5 billion. Achieving these targets would result in unified budget receipts of $795.7 billion, outlays of $967.6 billion, and a deficit of $171.9 billion. (The economic assumptions underlying the first resolution are those used by the administration in the February budget submission; see "Federal Fiscal Programs' in the February SURVEY for details.)

The budget submitted by the administration in early February included a $50.3 billion reduction in the fiscal year 1986 deficit. This reduction was to be achieved by reducing receipts $0.5 billion and outlays $50.8 billion. Unified budget receipts were estimated at $793.7 billion, outlays at $973.7 billion, and the deficit at $180.0 billion.

It does not appear, at least in these budget totals, that any significant change occurred in budget policy over this 6-month period. The resolution's estimate of the deficit is only $8.1 billion lower than the administration's estimate. (In mid-April, the administration revised the deficit estimate to $177.4 billion, and from that estimate, the resolution is $5.5 billion lower.) However, underlying the totals is a significant reordering of the administration's priorities. The resolution sharply scales back the administration's request for national defense spending and maintains nearly all of the programs the administration proposed to eliminate. The resolution, like the budget, does not include any significant tax increases. Unlike the budget, it does not make any changes to existing legislation providing cost-of-living adjustments (COLA's) for retirement programs; the budget proposed a 1-year freeze on COLA's, except for Social Security.

The budget resolution

In the budget process, the first budget resolution sets targets for budget totals and 21 budget functions, such as national defense and Social Security. (The first resolution should have been adopted by May 15.) A second resolution, which must be adopted by September 15, sets final totals for receipts and outlays. However, this year, the first resolution states that it shall be deemed the second resolution if Congress has not completed action on a second resolution by October 1, 1985.

Receipts.--As mentioned, the resolution does not call for any tax increases, but it would increase receipts by:

Requiring State and local government employees to participate in medicare;

Requiring Social Security coverage for newly hired State and local government employees; and,

Accelerating the deposit by State and local governments of Social Security taxes and of other deposits of various taxes, contributions, and fees.

The resolution does not indicate effective dates for these changes or how much the individual changes would increase receipts.

National defense spending.--In the administration's February budget, about 20 percent of the total outlay reduction was allocated to national defense. It was estimated that national defense spending in 1986 would increase 8.3 percent in real terms.

The resolution allocates 50 percent of the total outlay reduction to national defense and calls for no real growth in 1986 (3-percent real growth is assumed for 1987 and 1988). However, the administration may not have lost as much as it would appear, because national defense spending in 1986 will be influenced not only by the 1986 appropriation, but also by past appropriations and prior-year contracts and obligations. Furthermore, the resolution pieced the Senate budget authority estimate together with the House outlay estimate. The Senate budget authority and outlay estimates are $9.9 billion and $6.0 billion higher than the corresponding House estimates. Thus, if the appropriation committees accept the Senate budget authority, it would appear that outlays in 1986 could be higher than in the resolution.

Nondefense spending.--In the administration's budget, over 80 percent of the total outlay reduction was allocated to nondefense spending. The resolution allocates 50 percent of the reduction to nondefense spending. The resolution reductions would be achieved by cutting a wide variety of nondefense programs other than those aiding the poor by 20 percent to 30 percent. (Poverty programs, such as food stamps, would increase to keep pace with inflation.) Other actions, such as freezes on medicare payments to doctors and hospitals and on Federal civilian pay in 1986 and reductions of the strategic petroleum reserve fill rate, would also reduce spending.

The resolution calls for the expiration --at the end of fiscal year 1986-- of general revenue sharing, but generally does not cancel programs, such as urban development action grants and Export-Import Bank subsidized loans, that were canceled in the administration's budget. The administration proposed to end general revenue sharing a year earlier.

The resolution does not state the amount of outlay reductions on a functional basis; these amounts will be worked out by the various appropriations committees. However, the resolution does include instructions to various committees to achieve specified outlay levels. The instructions cover $68 billion of savings over the 1986-88 period.

Recent developments

In mid-August, the administration announced that the nondefense reductions in the resolution were not sufficient and that it would seek deeper cuts through the appropriation process this fall. The administration stated that it would seek--by the use of vetoes, if necessary--to hold nondefense spending to lower levels contained in a resolution approved by the Senate earlier this year.

The Department of Agriculture announced, also in mid-August, a new forecast of bumper crops in most major commodities this fall. Such crops could result in commodity surpluses of about the levels preceding the payment-in-kind program in 1983 and significantly increase farm-program costs. Both the administration and the resolution assumed major reductions in the farm program.

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

Table: 2.--Corporate Profits by Industry
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Title Annotation:second quarter, 1985
Publication:Survey of Current Business
Date:Aug 1, 1985
Previous Article:Fixed private capital in the United States.
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