Ahead Of Tomorrow's Jobs Number, A Big Red Flag: Tax Withholdings Slump

From NIck Colas of Convergex

Rubber Duckies and the Jobs Number

Given the volatility of recent U.S. labor market data, markets will pay special attention to Friday’s Employment Situation report. Current expectations are for 175-180,000 jobs added, somewhat better than the 3 month average of 140,000. Wage growth will be the other statistic of note, with last month’s 2.6% advance over last year as the benchmark.  Looking at individual tax/withholding receipts (available from the U.S. Treasury) for the month of July, there is reason for caution on both indicators.  July “Withheld” receipts – those tax and withholding payments that come straight from wage earner pay stubs – are down 1.0% year over year. 

This data series can be choppy, and looking at the three month trailing average yields a 3.1%.  That’s a touch slower than the 2016 YTD comp of 3.3%, and tells us to not expect too much from Friday’s number. 

Also worth noting: YTD non-withheld tax receipts (such as those that come from “Gig economy” workers) are down 6.5%, and July’s comp is 15% lower than a year ago

Last, corporate tax receipts are down 11% YTD, and if the current pace of these payments holds it will be the first negative comp since 2011. Bottom line: if the tax man isn’t as busy, can the U.S. economy really be expanding?

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In January 1992 a maritime storm hit a large container ship as it sailed from Hong Kong to Tacoma, Washington. As a result, several of the large metal boxes on deck were washed into the sea.  In one of those containers: 28,800 plastic bath toys shaped as beavers, frogs, turtles, and (yes) ducks.  Little yellow ducks, to be precise.

Ten months later, the ducks and other toys started to land on the Alaskan coast – 2,000 miles from where they had entered the Pacific during the storm.  A few years after that, they made landfall in Washington State.  Since then, amateur oceanographers have tracked these “Friendly floatees” (as they are now called) to Australia, South America, Malaysia and even the East Coast of the US and Great Britain.  The exercise has allowed scientist to apply their theories about ocean currents with a real-world example.  Read more here.

Economies have their own currents, of course, and tracing out which way they flow is a particularly vexing challenge at the moment.  The U.S. economy has been bubbling along in one direction since 2010, slowly expanding both in terms of inflation, labor markets and output.  The key question is when, or even if, the Federal Reserve wants to try to shift that current with incremental monetary policy. Chair Yellen and the FOMC, in turn, are trying to determine if the current is accelerating, slowing, or just staying the course.

Since the last few Employment Situation reports have been distinctly choppy (April 144,000, May 11,000, June 287,000), Friday’s release is an important measure of the economic “Current”.  The expected headline numbers are 175-180,000 jobs added and some continued wage growth above 2.0% year-over-year.  If labor markets show this kind of strength, the Fed will have more confidence to pursue a rate hike sometime later this year.  And if we get another data swoon, as we did in May, then they will be more likely to leave things as they are.

One related data set we look at ahead of “Jobs Friday” is actual tax receipts from the paystubs of working Americans.  The U.S. Treasury releases these with a 1 or 2 day delay, so the data is very fresh.  We’ve attached several charts to this note with historical observations, but here are the highlights:

  • Taxes and withholding collected directly from the paystubs of the U.S. labor force were down 1.0% in July from the earlier year. Now, this does not mean the domestic economy necessarily lost jobs in July – the data is notoriously choppy month to month.
  • The more instructive observation is to look at a 3 month rolling average, which shows tax/withholding receipts are 3.1% higher than last year.  And while that’s better than the one-month negative comp, it is clearly decelerating from its 3.3% rate for 2016YTD. Bottom line: tax/withholding receipts come from a combination of the size of the workforce and what they get paid. Slowing growth in receipts means that both/one of these components is decelerating.
  • Taxes paid by individuals who work as independent contractors (“Gig economy” workers like Uber drivers and real estate agents) are declining more noticeably, down 15% in July and 5.4% for the year-to-date. For comparison, consider that individual tax/withholding receipts – those we discussed in the prior point – are up 3.3% for the year to date.
  • From these two datasets, we see a combined picture of a labor market that is slowing but still nominally growing. It does seem that the ranks of the self-employed may be thinning, or perhaps they are just working less by choice (and therefore paying less in taxes and withholding).

Still, the decline in July’s withholdings and taxes is worrisome – if pressed, we would certainly take the “Under” on the consensus 175-180,000 jobs added estimate.

Another item in the Treasury’s data is the amount of taxes collected from U.S. corporations, and the recent trends there are surprisingly soft.  For the year to date through July 2016, corporate tax collections are down 12.6% ($170.4 billion versus $195.0 billion).  For the last 2 months, the comps to last year are -17%; the trend is not our friend. Moreover, corporate tax receipts now appear to have peaked in the 2015 FY (ending September) and never even made it back to 2007 levels ($385 billion then, $381 billion last year).

Now, there is a large ‘Chinese Wall’ between the U.S. Treasury and the Federal Reserve, which means that the central bank probably doesn’t see any more of this data than we do.  Which is a shame.  Now that most companies use automated payroll services it would be a relatively simple process to have these vendors do a hard count of the exactly how many people were on the books and pass the data along to the Federal Reserve and to the public.

For now, however, we’ll have to rely on the rubber duck approach: toss some surveys into the current and see where they end up.