Up To 3.5% Of US 2013 GDP Could Evaporate Due To Enacted Tax Hikes

Tyler Durden's picture

When it comes to the impact of the just enacted 2013 tax hikes (payroll tax cut expiration affecting everyone together with the tax hike on those making over $400K), economists are in broad agreement on one thing: the first half of 2013 will be impacted by roughly a 1.0%-1.5% drop in GDP. However, a big question emerges when attempting to quantify the adverse impact on US growth as the year progresses past June 30. Most strategists and economists ignore this issue, and instead chose to believe that all shall be well as by July, the US population will be habituated to getting a smaller paycheck and general consuming behavior will no longer be impacted relative to a previous baseline.

Sadly, as we all know, there are three certain things in life: death, taxes, and the majority of economists being dead wrong, which is why it is prudent to consider an alternative, one which assumes that Americans don't "habituate" to being poorer, and do not revert to a baseline spending model, regardless how much economists "will" a given outcome (especially since no estimates take into account spending cuts, which may happen, and which will serve as a double whammy to consumption in addition to already enacted tax hikes).

Which is why we were surprised to learn that according to at least one model created by Goldman, the total consumption hit for all of 2013 (not just H1), may well be higher than what most people assume. In fact, as Goldman shows, based on a model conceived by Christina and David Romer, it is possible that US GDP growth in the second half is slashed by an additional 2-2.5%, something which very likely will tip the country into recession as the combined impact over the entire year could be as high as 3.5%, eliminating even the most optimistic forecasts for organic growth in the US for the new year.

But it gets worse. As Goldman observes, "based on our reading of the debate in Washington, we have become more concerned about our assumption that the automatic spending cuts (or "sequester") will be delayed into 2014. If the sequester takes effect as scheduled from March 1, this would present an additional downside risk to our growth forecast in the later part of the year."

So the worst case scenario for GDP growth from tax hikes alone is already 3.5%, and one may have to add to that another several percent in GDP reduction from an spending cuts, which might well lead to a 4-5% GDP drop in 2013 in the worst case, a case determined solely by the dysfunction in Washington.

Should this happen, the implications for monetary policy and even further easing at that point (on top of the already enacted, indefinite $85 billion per month), not to mention risk and hard assets, are self-explanatory.

From Goldman:

The Consumption Hit From Higher Taxes

•    We expect the $200bn increase in federal taxes on individuals to be a major headwind for the economy this year, shaving around 1 percentage point off the annualized growth rate of personal consumption in 2013H1.

•    We compare this forecast to the implications from three empirical models including (1) a setup that traces out shocks to disposable income on consumption; (2) the Fed's macro-econometric model "FRB/US"; and (3) the approach pioneered by economists Christina and David Romer, who compile a history of legislated tax changes. The results suggest that our expectation for a 1 percentage point fiscal drag on annualized consumption growth in 2013H1 is broadly consistent with these models.

•    But there are risks to our expectation that the fiscal drag will diminish meaningfully in 2013H2. First, the Romer and Romer approach suggests that the tax hit to growth might continue to build in the second half of the year. Second, we have become more concerned about our assumption that the automatic spending cuts (or "sequester") will be delayed into 2014. This presents an additional downside risk to our forecast that growth will pick up to a trend rate in 2013H2.

Federal taxes on individuals in 2013 are likely to rise by around $200bn, worth 1.3% of GDP or 1.6% of disposable personal income. This estimate adds the expiration of the payroll tax cut ($126bn) as well as the increase in upper-income taxes via expiration of the Bush tax cuts ($50bn) and healthcare-related taxes ($24bn). We expect the resulting reduction in disposable income to be a major headwind for the economy this year, shaving around 1 percentage point (pt) off annualized personal consumption expenditure (PCE) growth in 2013H1. As a result, we forecast a slowdown of consumption growth from a bit more than 2% in late 2014--currently tracking at 2.2% in 2012Q4--to 1.0% in 2013Q1 and 1.5% in 2013Q2.

In today's comment we compare this forecast to the predictions from three models designed to estimate the effects of tax increases on consumption.

First, we consider an empirical model that traces out the effects of changes to disposable income on consumption. We construct a quarterly vector auto-regression (VAR) model that explains the (annualized) growth rate of real PCE with the quarter-on-quarter percentage change in real disposable income. We then trace out the response of real PCE growth to a 1.6% reduction in real disposable income in early 2013. The black bars in Exhibit 1 summarize our results. The model points to a sizable hit of 1.5pt to (annualized) real PCE growth in the first half of the year. The drag then diminishes to about 0.5pt in 2013H2.

Second, we turn to the Fed's large-scale econometric model of the US economy, FRB/US. The motivation is that FRB/US is far more comprehensive than our simple setup above, For example, it allows consumption to depend not only on current disposable income but also expectations about its future path. Within FRB/US we model the 2013 tax increase as a permanent 1.6% hit to expected lifetime disposable income. In effect, we assume that households expect the tax increase to remain in place for the foreseeable future. We then trace out the effect on consumption in the model. The results are broadly similar to the simple model above, pointing to a 1pt hit to annualized consumption growth in 2013H1 and 0.5pt in 2013H2.

Finally, we use the "narrative" data set constructed by Christina and David Romer of the University of California, Berkeley. It is based on detailed historical records from Congress and the US Treasury on legislated tax changes, with a special focus on "exogenous" changes that are not motivated by a desire to respond to changes in economic activity. (The intuition for their approach is that excluding tax changes that were conducted in response to the state of the cycle makes it easier to disentangle cause and effect of tax changes.) As in our simple approach above, we estimate a quarterly VAR that includes real PCE growth and the Romers' measure of tax changes. We then trace out the effect of a 1.3% of GDP increase in taxes in early 2013 on real PCE growth. Although the results are similar for 2013H1--with a hit of around 1pt--the hit to consumption is much larger in the second half of 2013 than with the approaches above (Exhibit 1). Instead of fading away in 2013H1, the drag on consumption growth continues to build in the second half of the year. This conclusion is qualitatively similar--although less pronounced--when we allow for monetary policy to lean against the consumption hit.

We conclude that our forecast of a 1-percentage-point fiscal drag on consumption growth in 2013H1 is broadly consistent with our survey of alternative empirical models. This would probably imply a small decline in real personal consumption in January followed by slow but positive growth in subsequent months. The timetable of indicators discussed in yesterday's comment should help us assess whether our forecast is correct.

But there are risks to our expectation that the fiscal drag will diminish in 2013H2. First, as the Romer and Romer approach shows, it is possible that the effects from the tax hikes on growth will continue to build in the second half of the year. If so, our forecast for a return of real GDP growth to a trend rate of 2.5% in the second half would be at risk.

Second, based on our reading of the debate in Washington, we have become more concerned about our assumption that the automatic spending cuts (or "sequester") will be delayed into 2014. If the sequester takes effect as scheduled from March 1, this would present an additional downside risk to our growth forecast in the later part of the year.

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
syntaxterror's picture

The Obamunists will just Print-n-Spend™ moar. Problem solved.

orangegeek's picture

Loss of GDP (shrinking economy) should reflect nicely on the SP500 weekly.




Markets keep pushing higher on very little - when markets turn down, it's going to get a lot worse.


And tax revenue will likely plumment.

CrashisOptimistic's picture

It's hard to do the math on the Soc. Sec. Payroll tax because not everyone pays it.  Teachers usually don't, for example.

The general number for that is about 150 Billion dollars.  That's out of paychecks all the way to December, so I know it was somehow popular to say the drag was only to be on Q1, but it's year long.

Tack on the $60 billion out of millionaire pockets and you have a sum of $210 B.  The GDP is about $15.3T so 0.21 / 15.3 = 1.37% drag.  There can be multipliers, true, with lower GDP generating more unemployed and lift the drag number.  But 1.37% is a good baseline starting point.

The Sequester would be $110B for 2013 (and one wonders if all of it will be applied, given a 1 March start).  See the "Fiscal Cliff" wiki for an excellent layout of Sequester.  But regardless of all that, the sum hit on GDP then is $210 + $110B = $320B or 2.1%.

Those are all the numbers already slated to become law.  Then we have the likelihood of MORE spending cuts to be demanded by the GOP for 2013 spending.  What was done in 2011 was back load them, and maybe that will happen again, in which case we'll have Sequester year 2 (another $110B) plus the back loaded total . . . probably at least another $100B.  

So in general GDP faces 1.5% drags every single year for at least 10 years upcoming (not to mention that oil is now $10 more than 2 months ago).

falak pema's picture

whats this obsession with the GDP?

3.5% up in smoke? 

WHen there are 700 T of derivatives unresolved? 

Count your fiat value in terms of private debt and pubic deficit. The two are one.

GDP is nothing if its a measure of living off other people's weath. Thats where we are going. And the Oligarchs have debased the first world labour component to zilch in order to PROTECT their fiat wealth in electronic money assets.

How about that? 

Now you know buyng stakes in Apple or Facebook is the blood of electronic wealth. Where the slaves work for nothing and the consumers consume on runaway debt with products made with huge margins for the 1%.

Thank you all, our profits and your runaway debts. 

And man must we protect them by defending the GDP meme of Oligarchy profit built on plebian sweat and ever increasing debt.

Keep climbing that hill to pay off your debts; sheeple. 

And let the Austrians sell you austerity to make you feel you are tainted with original sin; and they the super efficient with eternal virtue based on derivative "indulgences". God looks after his own. 


CrashisOptimistic's picture

Not too sure I or anyone knows what that gobbledygook means, but if you're advocating rejecting debt and walking away, be aware one man's debt is another's asset -- and pension plans are loaded with Treasuries.

Go ask Mom and Dad if they want to eat when they are 65.

LawsofPhysics's picture

Mom and dad have plenty of physical and almost 20,000 acres of arable land generating a considerable amount of fiat per annum, oh sorry, did you have a point.  Really don't give a shit about treasuries, grandpa warned them already.

LawsofPhysics's picture

Let me say it again.  Long black markets, any physical assets of real value, and a trustworthy and well armed tribe to protect it with.

Fuck the motherfucking paper-pushers, I love being debt-free.  Welcome to the rentier society bitches, pay up.

falak pema's picture

While we navel gaze at our ascending debt escalator and our deficit barometer; take a look what its like in the crazy world of third world confrontation between the "Jihad brigade of regressive obscurantism" and the "neo colonial brigade of extractive empires" now flaring up in Mali.

Another local war in Africa. Ain't that cute. the West uses Al Qaeda as ally in Syria and labels the same as enemy in Mali.

We don't know the difference between debt and asset and friend and foe! 

What next? 

VIDÉO. L'intervention des forces françaises au Mali a débuté

Joe Davola's picture

So in the current operative version of the NWO, it is:  the friend of my friend is my enemy

It's too late on a Friday afternoon for this new math stuff.



alangreedspank's picture

Taxes don't matter! Oops, seems like they do after all... *reverts into rationalizing this as being good for the environment*

Quinvarius's picture

They think that if we don't have the money they print, hyperinflation can't happen.  Which is hilarious and absurd.  But the collectivists want us poor and helpless.

ebworthen's picture

Surely if a retailer raises their prices their monthly receipts will increase?

Why, all JC Penney has to do is raise prices in order to increase renveues, right?

I don't understand why the government isn't paying unemployed youth $1.00 per broken window to fix this economy!?!?

ejmoosa's picture

We are already entering a recession  Byt the end of 2013, we will be talking about a depression.


You can't suck this amount of profits into the government coffers and not have drastic changes is spending and consumption.  


The Free Ride ends here.

dadichris's picture

oh nooos! not the Gross *cough* Domestic *cough* Product *cough* !!!

hooligan2009's picture

only another 30% of gdp to go before we get the GDP that isn't paid for by living off the future generations..or paid for, by debasing the 70% that is real.(and which is the hope for the future)..wait til the fight gets srious about why bankers get paid fat bonuses and those earning less than 69,000 pay the fat bankers bonuses...

stop working, pay no tax, get your benefits and live the dream

The Alarmist's picture

I call bullshit! It's going back into the government hopper for spending that's keeping the rest of GDP afloat that would otherwise be borrowed money, so if you count the interest saved, the new taxes should actually be value accretive.

Walt D.'s picture

ECON 101 - when taxes are low the economy will grow. When taxes are high the economy will die.

(Perhaps they don't teach this any more. Like "price caps cause shortages" - wouldn't want anybody in Berkeley finding out the consequences of rent control!)

LawsofPhysics's picture

only if you have the ability to increase the available ENERGY is any growth possible.  The problem is eCON ignores physics and the laws of Nature.  Guess who always wins?

hooligan2009's picture

when government is stupid..taxpayers play cupid

to who gets fucked over next :) 

Taffy Lewis's picture

Tyler, terrible journalism on your part. You fail to dig deeper and explain that the tax hikes are due to Washington's austerity measures. I'm disappointed. (/sarc)

Americans feel austerity's bite as payroll taxes rise


"Americans are beginning to feel the pinch from Washington's decision to embrace austerity measures aimed at bringing down the nation's budget deficit."

"Most mainstream economists say the government should still be trying to stimulate the economy by lowering taxes or raising spending to help bring down the 7.8 percent jobless rate."

This is what passes for journalism and most Americans will eat this up as gospel.

I feel like I'm living in a parallel universe.