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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 $3 billion in the second quarter, following a $13 billion increase in the first.1 Domestic profits of nonfinancial corporations increased $2 1/2 billion after a $9 billion increase, domestic profits of financial corporations were flat after a $1 billion increase, and profits from the rest of the world were up $1/2 billion after a $3 billion increase.

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 1982 dollars.

PBT increased $11 1/2 billion in the second quarter after an increase of $9 billion in the first. The much smaller increase in profits from current production than in PBT was due to the IVA, which declined $8 1/2 billion. The IVA, like the CCAdj (which changed little in the second quarter), is reflected in the current production measure but not in PBT. The IVA converts the value of inventory withdrawals from the predominantly historical costs that underlie PBT to current replacement costs. When current replacement costs of inventory withdrawals are higher than costs that underlie PBT, the IVA is negative in order to remove the resulting capital-gains-like element from profits.

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 $3 billion in the second quarter after a $6 1/2 billion increase in the first.

In nonfinancial corporations, profits of petroleum refiners increased $10 1/2 billion (to $12 1/2 billion), more than accounting for the increase in manufacturing profits. The increase in manufacturing profits, however, was more than offset by a decline of $11 billion (to $45 billion) in trade profits. Over the past four quarters, movements in petroleum and trade profits have been large, choppy, and more or less offsetting. In each of these quarters, petroleum registered the largest change of any manufacturing industry, and trade, the largest of any nonmanufacturing industry. For both industries, an increase in one quarter was followed by a decline in the next, and a decline in one quarter, by an increase in the next. In each of the last four quarters, the large changes in petroleum and trade profits have been in opposite directions.

The choppiness in trade profits mirrors changes in the sales of wholesale and retail trade firms. The choppiness in petroleum profits is not susceptible to brief explanation because of the complex structure of the industry; the same economic developments affect disparate segments of the industry differently. For example, other things equal, a substantial increase in crude oil prices such as occurred this year squeezes the profits of refiners. In contrast, for integrated firms the effect on profits from extraction would offset the effect on profits from refining; however, if the extraction occurs overseas, profits from the rest of the world would increase, not profits in the domestic petroleum industry. A further complication arises because integrated firms typically sell some crude to nonaffiliated refiners while purchasing some from nonaffiliated producers; a change in the relationship between crude and product prices, if it affected the amounts sold and purchased, would affect profits.

In financial corporations, profits changed little. Major banks made very large additions to loss reserves in the second quarter in connection with their outstanding foreign loans. Profits in the national income and product accounts (NIPA's), however, are not affected until loans are actually charged against reserves by the banks.

Federal Budget Developments

Revised estimates of Federal unified budget receipts and outlays for fiscal years 1987 and 1988 were submitted to Congress by the Office of Management and Budget in mid-August. The revised deficit for 1987 is $158.4 billion, and for 1988, $123.3 billion, Both are higher than the targets specified in the Gramm-Rudman-Hollings Act (formally, the Balanced Budget and Emergency Deficit Control Act of 1985).

In February 1986, the administration submitted a fiscal year 1987 budget with a deficit slightly under the $144.0 billion target for that year. Both the Congress' June 1986 concurrent resolution on the 1987 budget and the administration's August 1986 mid-session review contained estimates under $144.0 billion. In January 1987, the administration's 1988 budget submission contained an estimate of $173.2 billion for the 1987 deficit --$29.2 billion more than the target. Stronger-than-expected tax collections in the spring of 1987 helped to bring the estimate in the August 1987 mid-session review considerably closer to the target.

The administration's January 1987 budget estimate for the fiscal year 1988 deficit was just under the Gramm-Rudman-Hollings $123.3 billion target, and the June 1987 concurrent resolution on the 1988 budget met the target by continuing to use the administration's January economic assumptions. The new mid-session review estimates, however, exceed the 1988 target by $15.3 billion. Congress has not yet passed a revised budget resolution, but during debates in August concerning a debt ceiling extension, the Senate approved a revised target of $150.0 billion and House conferees on the bill offered a target of $144.0 billion. As of mid-September, Congress was debating changes to the Gramm-Rudman-Hollings Act to strengthen the enforcement mechanisms and raise the target deficits.

The mid-session review

The new estimates of unified budget receipts and outlays for fiscal years 1987 and 1988 reflect revised economic assumptions, legislation enacted by Congress this year, policy changes, and reestimates of tax collections and agency spending based largely on experience since the January 1987 budget. (See the February 1987 SURVEY OF CURRENT BUSINESS for a discussion of the January budget.)

Two pieces of legislation enacted since January had a substantial impact on the budget estimates. In April, Congress overrode a presidential veto to enact the Surface Transportation and Uniform Relocation Assistance Act of 1987; the act provided for more spending from the highway trust fund than the administration had requested. In July, the 1987 Supplemental Appropriations Act appropriated more for several programs than the administration requested.

On the basis of the revised economic assumptions, real GNP increases one-half a percentage point less in calendar year 1987 than expected earlier this year, but at the same rate-- 3.2 percent--from the fourth quarter of 1986 to the fourth quarter of 1987 as expected earlier (table 1). From the fourth quarter of 1987 to the fourth quarter of 1988, real GNP increases 3.5 percent, slightly less than expected earlier. In both years, personal income is higher than expected earlier and corporate profits before taxes are lower. Reflecting higher-than-expected inflation during the first half of 1987, consumer prices rise more than expected earlier; the interest rate on 10-year Treasury notes is also higher. The unemployment rate, reflecting the recent larger-than-expected drop, is lower than expected earlier.

Unified budget.--For fiscal year 1987, a $158.4 billion deficit is estimated, compared with $173.2 billion estimated in January (table 2). Receipts are $16.1 billion higher; an upward revision of $21.9 billion due to reestimates--including reestimates of the impact of the Tax Reform Act of 1986 (see the next section)--is partly offset by a downward revision of $6.4 billion due to revised economic assumptions. Among the major categories of receipts, there are large, partly offsetting revisions in the two income tax components. Individual income taxes are revised up $28.8 billion to $392.8 billion, and corporate income taxes are revised down $15.2 billion to $89.6 billion.

Outlays in 1987 are $1.3 billion higher; upward revisions of $3.5 billion due to policy changes and $0.9 billion due to economic assumptions are partly offset by a downward revision of $3.1 billion due to reestimates. On a program-by-program basis, the revision is the net of $11.0 billion in upward revisions and $9.7 billion in downward revisions. The largest upward revision is for net interest ($2.1 billion), reflecting a different mix of borrowing than had been expected earlier and higher interest rates. The other major upward revisions are $1.3 billion for Federal Housing Administration mortgage insurance, $1.1 billion for medicare, $1.0 billion for medicaid, and $1.0 billion for the foreign military sales trust fund. The largest downward revisions are $3.3 billion for the Federal Deposit Insurance Corporation (FDIC) and $2.1 billion for the Commodity Credit Corporation (CCC). The revision for the FDIC is due to lower cash outlays per bank closing; the revision for the CCC is due to changes in the supply and demand estimates for crops.

For fiscal year 1988, a $123.3 billion deficit is estimated, compared with $107.8 billion estimated in January. Receipts are $7.6 billion lower; a downward revision of $9.4 billion due to revised economic assumptions is partly offset by a $2.0 billion upward revision due to reestimates. Among the major categories of receipts, the largest revisions are an $11.8 billion reduction in corporate income taxes and a $3.3 billion increase in individual income taxes.

Outlays in 1988 are $8.0 billion higher; upward revisions of $4.3 billion due to policy changes and $5.7 billion due to revised economic assumptions are partly offset by a $1.8 billion downward revision due to reestimates. On a program-by-program basis, the revision in outlays is the net of $17.3 billion in upward revisions and $9.3 billion in downward revisions. The largest upward revision is for net interest ($5.7 billion), most of which is attributable to higher interest rates. Other upward revisions include $1.5 billion for medicaid, reflecting higher actual and estimated State benefits, and $1.1 billion for Social Security, reflecting the effect of the revised assumption about consumer prices on the January 1988 cost-of-living increase (a 4.2-percent instead of a 3.5-percent increase). The largest downward revision is for the CCC ($5.3 billion), attributable to changes in the supply and demand estimates for crops. Lower unemployment rates reduce unemployment insurance benefits by $1.1 billion, and lower cash outlays per bank closing reduce FDIC outlays by $1.1 billion.

Revised NIPA estimates.--BEA has prepared estimates of the Federal sector on the national income and product account (NIPA) basis consistent with the revised unified budget estimates (table 2, and table 3 for the quarterly pattern). On this basis, fiscal year 1987 receipts are $24.8 billion higher than estimated in January, expenditures are $0.9 billion higher, and the deficit is $23.9 billion lower.

The upward revision in receipts is more than accounted for by an upward revision of $29.3 billion in personal tax and nontax receipts; $16.3 billion of this revision is attributable to nonwithheld income tax payments, $11.0 billion to withheld income tax, and $1.9 billion to estate and gift taxes and personal nontaxes. The most important factor in the revision to nonwithheld taxes is higher-than-expected payments in 1987 by taxpayers who had realized capital gains in 1986 in order to benefit from preferential treatment of that income; under a provision of the Tax Reform Act of 1986, capital gains realized after 1986 will be taxed as ordinary income. Partly offsetting the upward revisions is a downward revision of $5.1 billion in corporate profits tax accruals, largely due to lower corporate profits.

The revision in expenditures is the net of $11.3 billion in upward revisions and $10.4 billion in downward revisions (including a revision to wage accruals less disbursements, a category that is subtracted in deriving total expenditures). The largest upward revision is for subsidies less the current surplus of government enterprises ($3.9 billion), reflecting higher estimates for agricultural subsidies and for the CCC deficit. The other large upward revisions are for transfer payments to persons ($3.0 billion), net interest ($2.2 billion), and grants-in-aid to State and local governments ($2.1 billion). The revision in transfer payments to persons reflects higher medicare benefits, and the revision in grants-in-aid reflects higher grants for medicaid, education, and several other programs. The largest downward revision--$8.8 billion--is in nondefense purchases and reflects lower net purchases of agricultural commodities by the CCC.

For fiscal year 1988, receipts are $8.2 billion lower than estimated in January, expenditures are $9.7 billion higher, and the deficit is $17.9 billion higher. The downward revision in receipts is more than accounted for by a $14.0 billion downward revision in corporate profits taxes, largely attributable to lower corporate profits. An upward revision in personal tax and nontax receipts ($5.5 billion) is a partial offset.

The revision in expenditures is the net of $15.5 billion in upward revisions and $5.8 billion in downward revisions. The largest upward revision-- $5.6 billion--is for transfer payments to persons, reflecting higher medicare benefits and the larger January 1988 cost-of-living increase for Social Security and other programs. Net interest paid is revised up $5.1 billion, reflecting higher interest rates. Grants-in-aid are revised up $4.8 billion; the upward revisions are in education, medicaid, highways, and several other programs. The largest downward revision --$3.2 billion--is for subsidies less the current surplus of government enterprises and primarily reflects lower agricultural subsidies Nondefense purchases are revised down $1.4 billion; a $3.4 billion reduction in CCC purchases is partly offset by upward revisions in purchases for other programs. Transfer payments to foreigners and national defense purchases are each revised slightly.

Table 4 shows the relation between unified budget receipts and NIPA receipts, and table 5 shows the relation between unified budget outlays and NIPA expenditures.

Cyclically adjusted deficit.--As measured using cyclical adjustments based on middle-expansion trend GNP, the Federal deficit on the NIPA basis decreases $41.0 billion in calendar year 1987 (table 6). On a quarterly basis, the pattern of the cyclically adjusted deficit is similar to the pattern in the NIPA deficit. The cyclically adjusted budget based on middle-expansion trend GNP is associated with a middle-expansion trend unemployment rate of 7.4 percent. The cyclically adjusted deficit based on a 6-percent unemployment rate is lower, but follows the same quarterly pattern.

Tax Reform Act of 1986: Revised estimates

The March 1987 SURVEY contains a discussion of the Tax Reform Act of 1986 and its impact on Federal Government receipts and expenditures on a NIPA basis. Table 7 presents revised annual and quarterly estimates based on the mid-session review of the budget; these estimates incorporate revised economic assumptions as well as later tax collection experience.

Total NIPA receipts are revised up $6.2 billion in 1987, down $1.3 billion in 1988, and down $6.4 billion in 1989. Personal tax and nontax receipts are revised up $7.5 billion in 1987, up $1.1 billion in 1988, and down $6.6 billion in 1989. The 1987 revision includes an upward revision of $15.1 billion in nonwithheld income tax, which is partly offset by a $7.6 billion downward revision in withheld income tax. The most important factor in the revision to nonwithheld income tax is higher-than-expected payments in 1987 by taxpayers who had realized capital gains in 1986 in order to benefit from preferential treatment of that income; under this act, capital gains realized after 1986 will be taxed as ordinary income. Corporate profits tax accruals are revised down $1.3 billion in 1987, down $2.4 billion in 1988, and up $0.2 billion in 1989. The estimates of the impact on indirect business tax and nontax accruals and on contributions for social insurance are not revised.

Second-quarter NIPA revisions

The second revisions of the NIPA estimates for the second quarter of 1987 are shown in table 8, on page 19.

Table: 1.--Economic Assumptions Underlying the Mid-Session Review of the Fiscal Year 1988 Budget

Table: 2.--Federal Government Receipts and Expenditures

Table: 3.--Federal Government Receipts and Expenditures, NIPA Basis

Table: 4.--Relation of Federal Government Receipts in the National Income and Product Accounts to the Unified Budget

Table: 5.--Relation of Federal Government Expenditures in the National Income and Product Accounts to the United Budget

Table: 6.--Cyclically Adjusted Surplus or Deficit (-), NIPA Basis

Table: 7.--Impact of the Tax Reform Act of 1986 on Federal Government Receipts and Expenditures, NIPA Basis
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Title Annotation:second quarter, 1987
Publication:Survey of Current Business
Date:Sep 1, 1987
Words:2740
Previous Article:Fixed reproducible tangible wealth in the United States, 1983-86.
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