Capex & Taxes; What The Corporate Sector Is Saying About The Economy (Spoiler Alert: Nothing Good)

Authored by Jeffrey Snider via Alhambra Investment Partners,

Private US businesses are not building new facilities, or renovating old ones, at a rate that suggests the economy is doing well. Let alone booming. For more than two years now, the aggregate level of Private Non-residential Construction Spending has been flat.

According to the Census Bureau in figures released today, construction capex in July 2018 (seasonally adjusted) was less than 2% above what took place in July 2016. Compared to November 2016, there was less spending in the latest month than during the height of Reflation #3.

In between, it does seem as if the US economy was “rescued” to a substantial degree by Keynesian economics. The destruction of so much capital material by the storms Harvey and Irma appears to have triggered a temporary reprieve. In terms of construction spending, things were headed the wrong way in the middle of last year until Mother Nature took over.

Now without the “benefit” of mindless devastation the sector is turned lower again. This despite what is supposedly a robust economy not just here but in many other places around the world (globally synchronized growth). If that is so, why aren’t businesses behaving like it and preparing for these better days, meaning higher volumes, that are supposedly here already?

In terms of public construction, there is also a little bit of both; meaning clear effects of tropical storms that only leave us with questions about everything else. Public construction spending jumped in October and November 2017, as you would expect. The splurge continued on all the way until May 2018.

Public construction has been slightly lower since, though in the short run there isn’t much confidence in the data (revisions in this series tend to be severe at times; construction spending for May 2018 was revised sharply lower, so it may be over the coming months the data could be significantly revised in either direction). Is this a temporary pause as local governments digest the last few months? Or are recently raised tax issues putting the brakes on current plans?

There had been an increase in tax collections at the state and local level throughout last year. That might have been the incentive for those governments to carry out or restart projects delayed by several years of interrupted taxation (so much for the 2014 predictions, as municipal tax collectors spent all of 2015 and 2016 wondering why additional receipts had just disappeared).

But already in 2018, beginning really in Q4 2017, taxation has slowed. On a rolling 4-quarter basis, total local and state collections through Q1 2018 were only 1.5% more than in the four quarters up to Q4 2017. That’s down from a peak rate of 2.2% at the end of last year. That’s substantially less than the peak during the 2013-14 upturn which reached nearly 3% at its top.

In other words, tax collections have rebounded but not by nearly as much as perhaps local governments may have been expecting as derived from mainstream economic forecasts (relying mostly on the unemployment rate). Now in 2018, at least through Q1, growth of receipts may have already turned the other way.

And in one particular tax category collections fell: corporate income taxes. Year-on-year, local and state taxes on corporate business declined by 4% after rising only 12% in Q4. More importantly, on a rolling 4-quarter basis corporate taxes were off by 0.7% in the latest estimates.

This particular data might provide us with two answers in one, explaining in one sense the potential reluctance on the part of local governments to maintain building and construction at the same pace. If taxes are volatile in corporate income, it might also propose why corporate businesses aren’t enthusiastic about their own capex, outside of necessary rebuilding in Texas and Florida.

As you can see above and below, the behavior of corporate tax payments tends to mirror the overall economy. When collections are weak and even contracting, those have been the times the economic condition is in doubt or worse: 1997-98 Asian flu; 2001-02 dot-com recession; 2007-09 Great ‘Recession’; 2012 slowdown/downturn; 2015-16 “rising dollar” downturn; 2018, too?

Corporate taxes are not a big part of the state and local tax base. They amounted to only about $45 billion out of a total $1 trillion collected during the last four quarters (through Q1 2018). But that’s immaterial to the macro signal we are attempting to parse. In other words, it’s not how much in total companies are paying in local taxes and fees, it is whether that small tax bill is rising or falling telling us perhaps something more about the true state of the economy.

You can, after all, “manage” corporate earnings but unlike for stock investors there is every incentive to present the true state of economic profits to state and local “revenue” departments if it results in a lower tax liability (including avoiding fees). Corporate taxes are up since 2016, but like commodity prices they aren’t really up.

It corroborates other indications which suggest tremendous uncertainty. The three biggest inputs into any private business are labor (slowdown), capex (slowdown), and working capital, especially inventory (slowdown). Outside of financial “investment” in share repurchases (and most of those are clustered at the very top of the size scale), businesses don’t appear to be buying this boom.

They certainly aren’t building for one, nor are they paying municipal taxes like it is.