Updated: Aug 20, 2021
Government Total Expenditures
The amount of government spending recently has been very high. We have two bills, infrastructure, and stimulus, being massive ticket items. During the 2008 crisis, everyone was agitated about the $1 trillion spent for the bailout. However, today we're doing two $2 trillion bills. The government spending is undoubtedly high, and we're starting to see that show up in the reports for companies.
The graph below is looking at inflation concerns regarding earnings reports of companies and the correlation to inflation. When companies are giving their updates on goods, services, materials, labor, and the rest of their spending, it correlates with Consumer Price Index (CPI). We can see that it's up 12%, which is enormous.
However, we see an uptick in the concerns by companies, and we can see the CPI correlates with consumer products. We've been as high as this before, and we did not go negative in the previous recession from lockdowns. So, we're going off a higher base, and we're already above-target inflation of 2%.
Who is Seeing Inflation First?
Producers see the inflation in the pricing first. Here is just a snippet of several reports from different companies that are talking about significant price increases as they produce the product:
FAST (Industrials): "We are experiencing significant material cost inflation, particularly for steel, fuel, and transportation costs."
GIS (Staples): "Looking ahead, as we experienced a higher inflationary environment, our first line of defense will continue to be our strong holistic margin management cost-savings program. In addition, we are taking actions now and in the coming months […] to drive net
price realization that will benefit our FY2022. "
CAG (Staples): "we see input cost inflation accelerate in many of our categories and across the industry."
LW (Staples): "while the pandemic-related effects on our supply chain were the primary drivers of our cost increases, we also realized higher costs due to input cost inflation in the low single-digits. We expect that rate will begin to tick up in the coming quarters as edible oil and transportation costs continue to increase."
STZ (Staples): "similar to previous years, we're expecting substantial inflation headwinds in the low to mid-single-digit increase range, largely related to glass and other packaging materials, raw materials, transportation, and labor costs in Mexico. "
PPG (Materials): "We experienced a significant acceleration of raw material and logistics cost inflation during the quarter. Coming into the year, we were expecting an inflationary environment and had prioritized selling price increases across all of our businesses. This has helped us achieve solid price increases year-to-date. With a higher inflation backdrop, we have already secured further selling price increases and are in the process of executing additional ones during the second quarter. "
DOV (Industrials): "What we are going to fight against between now and the end of the year […] is inflationary input costs between raw materials, labor, and price/cost. […] the way it's looking, we may have to intervene on price again in certain of the businesses over the balance of the year."
TEL (Tech): "I would expect our margins to modestly improve as we work our way forward here into the third and fourth quarter based on some of the actions that are underway and our ability to combat some of the inflationary pressures out there. […] Certainly, we're feeling the biggest inflation right now is on the freight side. The freight inflation has been significant. And as we battled through there and there's a variety of reasons for that, including higher air freight and so forth in terms of that. And that's not unique to TE. Certainly, I think that's been as well-publicized across the overall supply chain. […] labor cost is not a major issue on the inflation side, but labor availability in certain places that COVID is more impacting continues to drive some inefficiencies."
These companies are discussing significant price increases as they produce their product due to supply and demand. If you look at the import price in the graph below, you can see a much higher spike than the CPI. The CPI is a blue line, and it is going parabolic. We also see it in the producer price index (PPI). As the companies push those out, then stock prices will continue to move up, which is a good thing.
Transitory – Short Term Components of Current Issues
What's causing the current issues are transitory (short-term component) at the moment. If we look at just how many ships are trying to get into ports due to the back-order on goods, you will see how incredibly expensive a shopping container goes for. It comes down to the supply and demand component because many people have done without specific goods, and they're trying to restock.
Although unemployment is high, we see a labor shortage in the lower wages across the board looking at the supply chain because it was disrupted due to the pandemic. Do we see this fixing itself over time? Yes, this is what we call transitory as supply-demand will come to a balance. However, we also have a monetary policy that is not transitory, which will be seen in food prices as they go up substantially.
There is also a discretionary component for the low and middle income, where if prices are going up on things they're demanding, and they have to use more of their paycheck to purchase these items. Then, they will have less of their salary to pay for other things. Therefore, everyone's inflation basket and experience are different. We can start to look at different groups on how inflation affects them differently. If we look at the bottom 10% (the median earner), we could see inflation is much higher than if we're looking at the top 10% of earners.
Suppose it's not a significant percentage, and everyone else has had to cut back elsewhere. In that case, the higher income will be able to spend money and go further because inflation is moving prices.
Biden's Tax Plan
Political unrest will support calls for higher taxes on higher-income earners. This is not a phenomenon that just happened in 2020. It has been going on for quite some time. We've made the argument that it's the federal reserve and their monetary policy that has benefited people with assets over those that make income.
The 1% and big divide between the different economic levels is something that's been prolonged. Therefore, it is easier to propose higher tax increases. The current tax plan wants to raise the corporate tax rate from 21% to 28%, restore top individual rates from 37% to 39.6%, subject wages above $400,000 to social security payroll tax, and taxes on capital gains as ordinary income.
We've been able to "print" money, and there has not been the inflationary effect, so why raise the taxes? If Biden's tax plan were to pass, this would not solve all the problems because it may not impact the number of government receipts coming in, and people change their behavior.
Also, there is a proposal to have the IRS donate $88 billion over the next ten years to make sure people are not gaming the tax system. Suppose you have to pay people to prevent any additional gaming of the system. In that case, that's money that you're not going to spend on the other government items, and it proves the point that when people are going to do a lot of things to prevent the tax from actually hitting right.
Although this is a higher than average tax increase, if we look at both of them together, it's not the highest. Supporters and critics of President Biden's tax plan have made various claims about the size of the tax proposals, ranging from "not big enough" to the "biggest tax increase in history," however it can be both.
By comparison to these past tax increases, in the first year, Biden's tax plan would increase federal revenue by 0.68% GDP, making it the tenth-largest tax increase since the 1940s. In the second year of Biden's plan, when the temporary expansion of the Child Tax Credit expires, the plan would increase federal revenue by 1.52% GDP, tying for the fourth-largest tax increase as a share of GDP since the 1940s.
In addition, Biden's proposal would raise significant revenue. The plan would also have a negative long-run effect on the American economy, lowering long-run output and after-tax incomes.
If we look at the tax foundation table above, they assume GDP will drop 1.62% on our future growth. Our capital stock will decrease, and it's the capital that allows for wage increases long-term. The more efficient your tools are that make you more productive; the more you can sell, and the higher wages you can pay.
Then, we would see a wage rate drop because of the tax increase. It's not just the wealthy that are going to feel this. The rich create businesses and spend a lot of the money to affect the people they hire if they have less of that. Then, it would cause an estimated half-million lost jobs due to tax increases.
Now, let's talk about tax revenue as a way to close the gap. We can change the way taxes are received, but that's not the problem. The problem is the amount of government spending. The graph to the left shows you the volatility and the growth rate compared to revenue. Revenue is relatively steady, and it continues to move up.
The graph on the right shows the revenue and stability (the green line) versus the spending. The spending is growing, and at the bottom, you can see the deficit. Therefore, it's the government spending that is causing a lot of the problems. So, if we want to make a significant impact on the deficit, the bigger thing to focus on at the moment is government spends.
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