Major developments reported by Chief Economist Bernard Markstein, Reed Construction Data, for commercial construction and the U.S. economy
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The biggest near-term threats to the United States economy emanate from our nation’s capitol: the fiscal cliff and the debt ceiling. As noted in last week’s blog, only the tax portion of the fiscal cliff was resolved. The spending part of the fiscal cliff was pushed back to the beginning of March. On the plus side, the tax issues were resolved. George W. Bush-era tax rates, with some adjustments noted below, were made permanent—at least as permanent as any tax rates ever are.
Income Tax Provisions
Tax rates on ordinary income for individuals with
adjusted gross income (AGI) taxable income (TI) greater than $400,000 and for joint filers with AGI (TI) greater than $450,000 were increased from 35% to 39.6%. Note that, due to the progressivity of the income tax system, the higher rate only applies to ordinary income above those thresholds. The tax rates on income below that remain the same as under the George W. Bush-era tax cuts for all taxpayers.
Tax rates on capital gains and dividends were increased to 20% for those same groups (greater than $400,000/$450,000) and were left at 15% for those below these thresholds.
Personal exemptions and itemized deductions are being slowly phased out, starting at $250,000 for single filers and $300,000 for joint filers. Even with the phase-out, taxpayers who itemize are permitted to use at least 20% of their allowable deductions.
The alternative minimum tax (AMT) was permanently fixed. The exemption levels were raised to those that were in force for 2012, and indexed for inflation. Prior to this change, the exemption levels would revert to lower, not-inflation-adjusted levels. Thus, the exemption levels had to be raised each year to keep thousands of taxpayers, for whom the AMT was not intended, from falling under the higher AMT rates.
Other Tax Provisions
The Social Security payroll tax holiday was allowed to expire at the end of 2012. The result was an increase in the payroll tax from 4.2% to 6.2%—a reversion back to the rate that prevailed prior to 2011. Always meant to be temporary, the tax holiday was originally enacted for one year, but then extended for a second. No such reprieve this time around. For many workers who had become accustomed to the lower rate, the reduction in their take-home pay came as a shock when they received their first paycheck this year. This drain on disposable personal income will be a drag on consumer spending.
The estate tax exemption, which will now be indexed for inflation, is $5.25 million for 2013. The top estate tax rate was raised from 35% to 40%.
The Research and Development tax credit and bonus depreciation for business was extended through the end of 2013. Some special depreciation rules were extended through 2014.
Refundable tax credits for low-income individuals and households, including the earned-income tax credit and the child tax credit, were extended for five years.
Numerous other non-tax provisions were enacted as part of the beyond-last-minute resolution.
Emergency unemployment benefits were extended through the end of this year. This extends payments for those individuals out of work longer than 26 weeks. Elimination of the extension would have been another drag on consumer spending.
Scheduled cuts in Medicare payments to doctors were eliminated for this year (an annual ritual, which needs a permanent fix along the lines of the AMT fix).
The farm bill was extended for a year, avoiding the “milk cliff”—an almost doubling of milk prices.
Spending and the Sequester
Sequestration was delayed until the beginning of March. Sequestration is an automatic across-the-board reduction in federal spending, with half of the reduction from defense. Some parts of defense and some parts of non-defense spending, such as Social Security, are exempted from sequestration.
In the meantime, even assuming sequestration is avoided, no one knows exactly which programs will survive, which programs will be cut, or even the amount each will be reduced. This uncertainty creates a problem for companies, including construction companies, that contract with the federal government. It also injects additional uncertainty into expectations for economic growth—a deterrent to investment and employment.
The Debt Ceiling
A more serious concern is the federal debt ceiling. The United States technically hit the debt ceiling in late December. Since then, the Treasury has been using various measures to keep the government running. According to the Congressional Budget Office, these tricks may reach their limits by mid-February or early March. We would not be surprised if the Treasury found additional means to keep the government operating for a few more weeks or even a few more months.
This game cannot be continued indefinitely. Failure to raise the debt ceiling would eventually mean a virtual cessation of many parts of the federal government. Payments would be delayed, including those for Social Security and Medicare and various federal payrolls. It would lead to a technical default of U.S. debt, since payments for maturing debt could not be made.
The hope is that the debt ceiling will be raised before any of these consequences come to pass. In the meantime, the issue injects more uncertainty into the economic environment—yet another weight on investment and hiring plans.
Despite all the challenges created by the politicians in Washington, D.C., December nonfarm payroll employment increased a seasonally adjusted (SA) 155,000, and November’s increase was revised up 15,000 to 161,000.
Although positive news, these increases are not large enough for an economy still trying to return employment to pre-recession levels. From the pre-recession peak in January 2008 to the recession low in February 2010, payroll employment fell by 8.8 million. Since that low, payroll employment has risen by 4.8 million, which still leaves the economy 4.0 million jobs below its previous peak level. The added uncertainty added to the economic outlook by the wrangling over the fiscal cliff and the threat of the debt ceiling have limited companies’ willingness to hire, reducing potential growth in employment.
December’s unemployment rate held steady at 7.8%, the fourth month in a row with a below 8.0% reading. The December not seasonally adjusted (NSA) unemployment rate for construction workers remained high at 13.5%, but was down considerably from December 2011’s 16.0%.
In 2012, 97,000 construction workers were hired, and the number of construction workers who were unemployed decreased by 222,000. That means 125,000 workers left construction for jobs in other sectors of the economy, retired, or sought some sort of training (e.g., entered college). Since the construction unemployment rate peak of 27.1% in February 2010, 497,000 more workers have been hired, and the number of unemployed workers has decreased 1.335 million for a reduction in the construction labor force of 838,000 workers.
Risks to the Economy
- The federal debt ceiling becomes effective
- A near-term drastic reduction in federal spending
- Debt default by one or more European countries
- Abandonment of the euro by one or more countries other than Greece
- A sharp spike in oil prices (50% or higher) for a sustained period (at least two months)