Fiscal flows (federal spending) has swung sharply negative versus last year. This just happened in a little over a week. Federal spending hit $1.55 trillion for the fiscal year ending Feb. 9. That was $32 billion over the prior year. Spending was growing at a rate of 3.5% year over year; a decent clip. Then we hit an air pocket. Spending is currently $1.67 trillion for the fiscal year through Feb. 16. It has dropped to $35 billion below 2016. That's a swing of nearly $70 billion to the downside in a little over a week's time. The growth rate has gone from 3.5% positive year over year to contracting 2% year over year.
IRS tax refunds are causing this. These are big government spending items this time of year. February is the biggest fiscal month for the U.S. government spending-wise. Last year, the government spent over $500 billion in February. Think of it as $500 billion in income flows to the non-government.
IRS tax refunds are running $37 billion below last year. The sharp discrepancy compared to last year is because of a new law that Congress passed in 2015, which went into effect his year. It requires the IRS to hold some tax refunds for a longer period of time. The tax refund flows are going to resume, eventually, and possibly even surpass last year's rate; however, people depend on these payments. The economy depends on these payments.
When explaining fiscal flows, I have used the example of filling up a swimming pool. The swimming pool represents the economy and national income. The government is a pump with a hose and there's water either flowing out of the pump and into the pool (deficit spending), or it's sucking water out of the pool (taxing more than it's spending; in other words, running surpluses).
Until about a week ago, the government had the water flowing out of the hose pretty good. The pool was rising, but now we'll say the rate of flow has been cut back. It's not sucking water out, but it has cut back. And there are leaks. The pool always has leaks (taxes and imports, for example). That means the water level is starting to fall.
The problem is, growth requires the water level to constantly rise. If it stops rising, the economy stops growing unless something else can push it along. That can be more exports (the foreign sector filling up the pool with their net spending) or households and/or businesses taking from their savings and spending more. I don't see much of either. If anything, the trade deficit is rising and personal consumption expenditures were weaker in the fourth quarter.
Stocks are rising on higher growth expectations. I've been all over this. We've seen a 15% rise in the Dow since the election, yet in the fourth quarter the economy grew at 1.9%; down from 3.2% in the third.
Trump's economic and tax plan does the following: It sets into law a tax rate for corporations, which is a rate that corporations already pay, if not less. It incentivizes exports while taxing imports, so the initial effect is an overall tax on the economy because the U.S. runs a perennial trade deficit (we import more than we export). That might change over time as a result of the new tax policy, but it will take time, so the immediate effect is a tax.
The final prong consists of a proposed plan to charge a one-time low tax rate on repatriated earnings, which I don't think many corporations will take advantage of simply because it means, in most cases, a de-facto scaling down of foreign operations (you need those retained earnings for investment, expansion, etc.), and without a guaranteed offset in domestic demand, they will be hesitant. Trump is also relying on those repatriated profits to fund infrastructure, so I don't see much there.
I could be wrong, but that's how I see it. I also see the market as being wildly optimistic on this. I think investors will ultimately be disappointed.