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The business situation.

the BUSINESS SITUATION

PROFITS from current production-- profits before tax (PBT) with inventory valuation adjustment (IVA) and capital consumption adjustment (CCAdj)--increased $24 billion in the first quarter of 1987, following a $9 billion increase in the fourth quarter of 1986. Domestic profits of nonfinancial corporations increased $20 billion, and domestic profits of financial corporations increased $1 1/2 billion; in the fourth quarter, both had increased $4 billion. Profits from the rest of the world were up $2 1/2 billion, following a $1 1/2 billion increase.

PBT increased $8 billion in the first quarter, following an increase of $19 billion in the fourth. The much larger increase in profits from current production than in PBT was due to the CCAdj, which increased $16 billion. The CCAdj, like the IVA (which changed little in the first quarter), is 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 Tax Reform Act of 1986 (TRA) permitted more accelerated depreciation for tax purposes by providing that, in most cases, assets can be depreciated under a 200-percent, rather than a 150-percent, declining balance method. The resulting increase in tax-based depreciation produced the very large increase in CCAdj in the first quarter.

Corporate profits tax liability increased $13 1/2 billion. This increase, in conjunction with the $8 billion increase in PBT, produced a $5 1/2 billion decline in profits after tax.

The much sharper increase in taxes than in PBT reflects the impact of the TRA. Although the more accelerated depreciation and lower statutory tax rates of the TRA had the effect of reducing first-quarter taxes, this effect was more than offset by other provisions of the act that either resulted in more income being subject to tax-- such as the enactment of a minimum tax and limitations on certain business expense deductions--or shifted the timing of income and expense recognition --such as the changes in accounting procedures related to capitalization rules and the treatment of installment sales and bad debt reserves.1

1. For a detailed discussion of the tax law changes and Treasury Department estimates of the revenue effects, see "The Tax Reform Act of 1986,' SURVEY OF CURRENT BUSINESS 67 (March 1987): 18-25.

The changes mandated by the TRA necessitate adjustments to the methodologies used to estimate PBT and corporate tax liability in the national income and product accounts (NIPA's).2

2. For a description of the methodologies, see U.S. Department of Commerce, Bureau of Economic Analysis, Corporate Profits: Profits Before Tax, Profits Tax Liability, and Dividends, Methodology Paper Series MP-2, (Washington, DC: GPO), May 1985.

Usually, quarterly taxes are derived by applying an effective tax rate to PBT. For 1987, the resulting estimate is modified by BEA's estimates of the tax impact of changes in depreciation schedules and of the repeal of the investment tax credit and by the Treasury Department's estimates of the impact of other changes in the tax law.

Quarterly estimates of PBT are obtained by extrapolating largely on the basis of reports to the Census Bureau, to regulatory agencies, to trade associations, and to stockholders. Incomplete information available to BEA at this time suggests that corporations, by and large, did not implement the TRA's new accounting procedures in these reports in the first quarter; in the few instances where BEA determined that the new accounting procedures were used, however, adjustments were made to remove their effects from PBT. BEA will continue to monitor these reports for changes in corporate accounting practice and will continue to make adjustments as required.

Internal Revenue Service (IRS) tabulations of tax return data on 1987 corporate profits will not become available to BEA until early 1990 and will not be incorporated into BEA estimates until July of that year. These data, presumably, will fully reflect the new accounting procedures, necessitating changes in estimation methodology. Some of the new accounting procedures (such as those relating to installment sales and bad debt reserves) will bring IRS and NIPA definitions of profits into closer conformity and, as a result, obviate the adjustments that BEA has heretofore made to IRS data. Other procedures (such as limitations on business expense deductions and certain aspects of the uniform capitalization rules) will drive the IRS and NIPA definitions further apart and, as a result, necessitate a new set of adjustments to the IRS data.

Profits by industry.--PBT with IVA and CCAdj is not available by industry; PBT with IVA alone, the best measure of industry profits available, increased $8 1/2 billion in the first quarter, following an $6 billion increase. Domestic profits of nonfinancial corporations increased $4 1/2 billion; domestic profits of financial corporations, $1 billion; and profits from the rest of the world, $2 1/2 billion.

In nonfinancial corporations, trade profits were up $8 billion and manufacturers' profits were down $6 1/2 billion. The increase in trade profits followed a $5 1/2 billion decline in the fourth quarter and extended the up-and-down pattern around a rising trend that has characterized profits in the industry since mid-1985. In manufacturing, a modest increase in profits of durable manufacturers was more than offset by a decline in profits of nondurables manufacturers. In nondurables, declines were widespread but most pronounced in petroleum. Contributing to the drop in petroleum profits was a 24 1/2-percent increase in refiners' acquisition cost of crude oil; the Producer Price Index for finished petroleum products, in contrast, increased 15 percent.

Profits of property and casualty insurance companies more than accounted for the increase in profits of financial corporations. In rest-of-world-profits, an increase in inflows from foreign affiliates of U.S. corporations more than offset an increase in outflows from U.S. affiliates of foreign corporations; both petroleum and nonpetroleum affiliates of U.S. corporations contributed to the higher level of inflows.

First-quarter NIPA revisions

Table 1 shows the second revision of the NIPA estimates for the first quarter of 1987.

Table: 1.--Revisions in Selected Component Series of the NIPA's, First Quarter of 1987
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Title Annotation:1st quarter, 1987
Publication:Survey of Current Business
Date:Jun 1, 1987
Words:1026
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