Is there Another Warning in the GDP Numbers?

According to the Commerce Department advance estimate of first quarter GDP released yesterday, the economy grew at a rate of 2.2% in January through March. Much has been said and written about this already. One additional note, however, deserves comment.

The most troublesome piece of the report was the decline in nonresidential fixed investment. This had been growing in 2011 and it suddenly went into decline in 2012. Some analysts believe that the sudden shift to decline is the result of differing rules for depreciation of equipment put into service in 2011 and 2012. This may have an effect, but on closer review, I believe that something entirely different may be at work here. Specifically, we may be seeing the first effect of the coming mega-changes to the tax structure that are due to kick in as of January of 2013. At that time, the Bush tax cuts expire, the payroll tax holiday expires, the AMT kicks in fully, and a few other provisions also hit which, taken together, will pull something in excess of half a trillion dollars out of the economy. Most individuals do not even have this event on their radar, but businesses are far more aware of future tax structures. Most business investments are viewed through the lens of the long term. In other words, companies look at prospective investments to see how long it will take for them to pay off and what the rate of return on the investment will ultimately be. A company looking four years ahead has to make an assumption as to what the tax rates will be during that time in order to come to a conclusion as to what the results of the investment will be.

Obviously, not all investments will be ruled out because of the upcoming tax changes and the resulting uncertainty. But it does not require all investments to be stopped to have a decline of 2.1% in real nonresidential fixed investment like that which the Commerce Department reported; only a small part of the investments need to be prevented.

When one looks at the components of the investment numbers, the likely effect of the so called Taxmageddon is even more apparent. Investments for efficiency are still growing, while those for increased capacities are declining. In other words, investment for equipment and software grew by 1.7% while investment for nonresidential structures declined by 12%. Companies are not building as many new plants or other buildings; these take time to build and are clearly subject to the vagaries of 2013 and beyond. Hence, the enormous drop in this categoy.

The truly scary thing about this point is that Taxmageddon is getting close, and nothing is being done about it. Rather than even trying to come to some consensus or compromise about how taxes will be levied in 2013 and beyond, president Obama is busy campaigning on the Buffett Rule and purported "subsidies" to oil companies. Meanwhile, American business is voting with its dollars, or, more precisely, American business is voting by withholding its dollars. This may mean that Obama's plan to use demagoguery on the tax issue to win the election will actually turn out to seal his defeat. After all, if business investment continues to fall, unemployment will rise and the economy will sputter and then decline.

Obama needs to put the good of the country first and his re-election second. Wow! Just writing that sentence made me laugh. It is like calling for snow in July.