Posted by: Josh Lehner | March 20, 2014

Tobacco and Taxes

Continuing with our occasional series on the state revenue streams, today I’ll briefly discuss tobacco taxes and focus primarily on cigarettes.

In terms of overall spending on tobacco and supplies, the consumer expenditure survey data shows a typical pattern across the country. That is, by and large, slowly declining spending (and revenues) but a big change following a tax increase. In 2009 the federal government raised the tax per pack of cigarettes from $0.39 to $1.01. This was the driver in the increase in spending, not that suddenly more individuals started smoking in 2009.

TobaccoSpending

Locally, we are seeing the same sort of pattern. As discussed previous in comparing border tax issues with Oregon and Washington, tax policy differences between the states results in behavioral shifts. Both states have seen the downward trend in cigarette packs sold, however the movement around these trends is the interesting part. When Washington raises their tax (the red line goes up), sales in Washington decline more sharply while sales in Oregon level off or hold relatively steady. The opposite is true when Oregon raises taxes. This implies quite a bit of cross border activity in sales (primarily Washingtonians buying in Oregon). Our colleagues at the Washington Economic and Revenue Forecast Council find that roughly half of the change in sales following an Oregon tax increase is accounted for in cross border sales — that is about half of the decline in sales is due to less Oregonians purchasing and half due to less Washingtonians buying in Oregon. These tax law changes, and behavioral patterns, do result in revenue forecast errors, as discussed in more depth previously in The Lund Report.

Cigarette_Packs

As part of the special legislative session near the end of 2013, one of the bills passed (HB 3601) raised the Oregon cigarette tax per pack from $1.18 to $1.31. To help put that increase in context, notice the decrease in the red line above. The tax differential between Oregon and Washington is still nearly as large as it has ever been, however there will be a behavioral response. To gauge this behavioral change in advance, I compared the static impact of the tax increase — that is, there will be no behavioral response — with that of the official revenue impact statement from the Legislative Revenue Office. As seen below, expectations are that the higher tax will bring in more revenue overall, just not quite as much as the static impact would suggest. The tax increase went into effect January 1, 2014 and as we get more sales data, our office will adjust this impact accordingly.

CigImpact

Finally, the graph below highlights how cigarette taxes are distributed for use. For more details, including other tobacco tax revenue (cigars, snuff, etc) and the outlook please see Table B.6 in Appendix B of our quarterly forecast.

CigDistribution

Overall in terms of the outlook, our office’s expectations are for the slow decline in cigarettes sold to continue moving forward. The recent increase in cigarette taxes will likely not decrease this trend too much, given the relatively small changes plus the differential with Washington remains large. However, as discussed previously when looking at spending patterns by age, retirement age households spend 48 percent less on tobacco and smoking supplies than due to those in their late 50s or early 60s. Like many revenue streams moving forward, the aging demographics will weigh on growth as the Baby Boomers move into their retirement years in the coming decade.

Posted by: Josh Lehner | March 19, 2014

Aging Revenues

Our office routinely makes mention of the slower economic and revenue growth in the coming decade as the Baby Boomers age into their retirement years. I just wanted to share a couple graphs on the matter, taken from some work our office did for the CFO and budget folks across state agencies. Using the consumer expenditure survey (CEX) data by age from BLS, the following shows a rough approximation of how income and spending change as people age. More importantly for our office’s work, and our counterparts in other states as well, how taxable income and spending patterns change with age. This income-sales tax comparison post from a year ago, goes into much more depth on these changes and also revenue growth and performance, for those interested in more.

CEX2012_IncExp

In terms of what older households (technically consumer units in the CEX parlance) do and do not spend money on, the following shows the change in spending across major categories for retirement age folks compared with those in their late 50s and early 60s (where about half of the Boomers are today). Overall, spending falls. A lot. In come categories, shockingly so. 27 percent decline across all categories, and 20-40 percent for most categories. The only categories to see an increase are health care, reading and cash contributions (gifts, donations, etc).

CEX2012_Exp

Generally, one tends to think of these spending declines as a sales tax state problem. Sure the income declines will affect Oregon, but these various spending declines are not discussed as much given we do not have a sales tax. However, they will certainly impact a lot of the state’s various revenue streams, what are largely called, Other Funds. These are not General Fund revenues (mostly personal income and corporate excise taxes) or Federal Funds (grants, etc). These include licenses and fees (DMV, fishing, hunting, etc), gas taxes, tuition (not many continuing education courses or college age children), alcohol and tobacco sales and the like. Our office has the general fund revenue outlook pegged around 10 percent per biennium over the extended horizon, compared with previous expansions at more like 16 percent, but the other revenue streams for the state will face downward pressure as well as the Baby Boomers continue to age into retirement and their spending patterns shift. These changes will not occur overnight, but over the next 5-10 years, this is certainly the expectation moving forward.

Posted by: Josh Lehner | March 14, 2014

The Hangover, States Edition

Tax return season is starting to heat up, with the filing deadline just about one month away. So far the state has processed and issued nearly 40 percent of expected refunds but received less than 10 percent of final payments — these come just before the deadline. Even so, it can be important to step back and look at expectations for state revenue as we head into peak filing season. As our office writes in our latest forecast publication:

Despite rising stock market and housing prices, the outlook for taxable investment income remains subdued in the near term. Many Oregonians cashed out capital gains in 2012 in anticipation of federal tax rate increases, leaving fewer gains to be realized for tax purposes going forward.

Even as the economic fundamentals improved in 2013 and stock markets boomed, expectations are for modest growth due to the hangover from the Bush tax cuts expiring. Oregon is not alone in this, as evidenced by the latest fiscal survey of states from the National Association of State Budget Officers (NASBO). The timing of the data here is a bit off, but FY12 are actual revenue growth across the 42 states’ worth of data available (43 states levy an income tax in some form but NH data is missing). FY13 data from the report is still an estimate and not finalized, while FY14 is a pure one year ahead forecast. Oregon values are the horizontal red lines.

NASBO_1214

The general pattern is clear. FY13 saw a bump in growth rates due to the stronger economy but primarily the pull forward of investment income. Based on conversations with colleagues across the country, FY13 likely came in even stronger when all was said and done. Even so, Oregon saw growth accelerate in FY13 but was just below the median state. However the top marginal tax rate for those affected by Measure 66 was also reduced from 11 percent to 9.9 percent in tax year 2012, thus holding down the overall growth rate in collections.

FY14 shows the expected hangover. The median state is forecasting 1 percent with the average actually at -1 percent. In a growing economy, particularly in a place like Oregon where employment growth accelerated as well, and with a booming stock market of nearly 30 percent growth, it is hard to not see 5-7 percent revenue growth — or more. However the taxpayer behavior a year ago is expected to be large enough to hold down growth this year. By late May we should know whether or not these outlooks prove correct.

In terms of the overall forecast for the biennium, also from our forecast publication:

Although the revenue outlook remains on track, the 2013-15 biennium is still young, and therefore significant uncertainty remains. Two income tax filing seasons remain between now and the end of the biennium. As such, many risks to the outlook remain. On the upside, if asset markets continue to boom or if Oregon’s traditionally strong migration trends and labor force growth reappear, a short-term spike in revenues remains possible during the 2013-15 budget period. At this point, it would take only about $100 million in unanticipated revenue to trigger the kicker law.

 

Our office’s next forecast is scheduled to be released May 28th, 2014 when we should have a good idea of how the tax season turned out.

Posted by: Josh Lehner | March 12, 2014

South Coast Update

This post continues with our regular series on the regions within Oregon. In our March quarterly forecast publication, we profiled the South Coast and Southern Oregon. For more, see the regional tab at the top of the page.

Much like the rest of the state, the South Coast has experienced two severe recessions – the early 1980s and the Great Recession – and two mild ones – 1990 and 2001 – over the past 40 years. The key difference is the extent, severity and duration of the early 1980s recession in Coos County. That recession, tied to the restructuring of the timber industry at the same time the Federal Reserve raised interest rates into double digits to choke off inflation, was the single worst regional recession on record in Oregon’s history. On net the South Coast did not fully regain the total number of lost jobs from the early 1980s recession until 1996, some 17 years after employment peaked in 1979.

SCoast_Unemp

Even with the major shakeup in the region in the early 1980s, the local economy continues to restructure to this day. Reliance on natural resource industries (both timber and fishing) continues to decline, as the importance of retirement income and tourism grows, adding jobs in retail, health care and leisure and hospitality in particular.

SCoast_LQ12

Like the rest of the state, the vast majority of the region’s migrants come from California. In terms of relative size, Californians overwhelmingly choose to live in Southern Oregon and on the South Coast. Approximately half of these California migrants to Coos and Curry Counties come from the greater Los Angeles area or San Diego. The other half come from Northern California (excluding the Bay Area) or the Central Valley. Hardly any come from the Bay Area itself. In terms of migration off the South Coast, the region losses population to the rest of Oregon – mainly to the Willamette Valley, but not to the Salem metro in recent years – and a little bit to Washington state – almost all to Clark County, with small gains from elsewhere in the state. See here for more on migration.

SCoast_Migration

Shown but not discussed in the document is the importance of housing and government to the local economy. As our office has pointed out numerous times, these industries tend to play a disproportionately large role in our rural economies and as these industries do well, so too does the region as a whole. This is certainly the case on the South Coast.

SCoast_HousingGovernment

For more information on the South Coast, please see the Oregon Employment Department website for the great work that regional economist Guy Tauer does.

Posted by: Josh Lehner | March 10, 2014

Portland Housing Update

Three quick graphs showing the Portland housing market and one on the price outlook. First, given the tight market of increased demand and no sustained increases in supply, prices continue to see upward pressure. The past few months have cooled off somewhat — likely just the seasonal pattern, but possibly hints of sustained slowdown in price gains. So long as the limited supply of homes continues, it will remain a seller’s market. Demand has returned to that 2,000 per month level seen during the 1990s and early 2000s, while supply is very very low. Expectations are for supply to increase quite a bit in the next 2-3 years with new construction picking up strongly and more existing homes being sold as well.

PortlandActionReport_0114

One item that is interesting is that with such a limited supply on the market, prices have jumped ahead of the overall housing stock. In a seller’s market, with competing bids, this is the pattern one would expect to see. As these more recently sold homes filter through into the overall housing stock, the home price indexes are now playing catch-up to the market. Over a longer period, these two measures of home prices should closely track each other, and moving forward they will likely converge. The two trend lines are based on the Case-Shiller for 1992-2003 and for 1996-2003, to produce a naive gauge of where prices might have been had we continued along at those growth rates over the past decade. Interestingly enough, even after the bubble and bust, prices today are somewhere around these naive trend lines.

PortlandHousing

In terms of housing affordability, the cost of owning a home (financing, taxes, routine maintenance, etc) increased substantially in 2013 as prices rose along with interest rates. With price gains moderating and interest rates holding steady, so too is overall affordability.

PortlandAffordability_0114

Our office’s baseline outlook for prices moving forward is simple: moderation. As supply increases to meet stronger demand, that will move the market away from a seller’s one to a neutral one or even a buyer’s market if supply increases enough to outstrip demand, which is not out of the question based on history. Prior to the bubble, home prices typically increased at the rate of inflation or just a bit stronger. We expect this to be the case moving forward, however in a world with 12% home price appreciation in the past year, one can quickly look pretty silly calling for inflation-adjusted prices to be effectively flat over the next couple of years. While the transition into a more stable, normal housing market equilibrium has not and likely will not be perfectly smooth, our office believes this outlook is fundamentally correct. Price gains will moderate. There is no question about that. The question is one of timing, and right now we expect it to happen soon, but the strong price gains are likely to continue until supply increases or demand falls.

HomePriceOutlook

Hopefully this coming price moderation will be for good reasons (increased supply and a stronger economy) and not bad reasons (demand falling due to financing costs and a weaker economy).

Posted by: Josh Lehner | March 7, 2014

Portland City Club: Inequality and Minimum Wage

On Friday, March 7th I will be part of a panel at the Portland City Club on Equal Pay, Income Inequality and the Minimum Wage. In keeping with our office’s nonpartisan, independent position, I will not be advocating for or against any particular policy position. However I will provide information and facts on where Oregon stands in terms of these topics. What follows is the background information I compiled to support my prepared remarks. Warning: This is lengthy and is designed to be more of a reference piece, so I have put the rest below the fold.

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Click here for the rest

Posted by: Josh Lehner | March 5, 2014

Getting There

The latest employment report is out and most importantly the annual benchmark revision has been released and shows more jobs added in 2013 than originally thought. This is right inline with our forecast, but is good and better news than the preliminary data indicated. As Employment’s Nick Beleiciks wrote a couple months back: Finally some real growth. As our office is wont to do, now for some graphs!

This first graph is an update comparing recessions in Oregon’s post-WWII history. We’re now just a little bit better than the recovery coming out of the early 1980s recession, but just barely. Based on our office’s latest forecast, Oregon is now just about 1 year away from regaining all of the recessionary job losses. We’re getting there.

Emp_Recessions

In terms of the number of jobs being added, right now the state is at three-quarters throttle. The just more than 40,000 annual pace is effectively on par with the gains seen last decade but a notch below the 1990s gains. The improvement in the pace of recovery in 2013 is clearly evident in the graph as more regions of the state came online. We’re getting there.

Emp_HistJobGains

While the number of jobs being added is picking up, so too is the growth rate. We’re up to a 2.7% pace in January, over the past year. In a historical context this is still a subdued rate of growth, but we’re up to about a three-quarters throttle rate here as well. We’re getting there.

Emp_HistJobGrowth

Right now our baseline forecast calls for about this same rate of growth over the next couple of years. It’s a big improvement over the growth seen during the early stages of recovery but not as strong as the typical expansion in Oregon. Are we too pessimistic? Can job growth reach 3-4%? If even more regions of the state improve (Lane County in particular), and there is a stronger cyclical rate of growth due to, say, household deleveraging is complete and/or corporations invest more, absolutely. However, slow growth coming out a financial crisis is the norm and the demographic trends moving forward will weigh considerably on growth rates as the Baby Boomers retire en masse. Our office is optimistic about the outlook, we just believe these larger forces will hold us back from the full, typical expansion rates of growth. And yes, overall we are getting there.

Posted by: Josh Lehner | March 4, 2014

Manufacturing and Business Investment

The manufacturing cycle remains strong. Even with the recent spell of bad weather, measures like Industrial Production, New Orders and the Purchasing Managers’ Index are all looking relatively good. One manner in which these will manifest themselves into stronger growth is through business investment in new plants and equipment. Currently U.S. corporate profits are at a record high both in terms of dollar value and as a share of the economy. Large profits and liquid assets on corporate balance sheets indicate firms are not investing much and this potential source of stronger economic growth is on the sidelines. One likely reason this has been the case is that these firms do not need to invest if they are not already using their existing facilities (including employees) at full capacity. As measured by the Federal Reserve, industrial production and capacity utilization are either back, or nearly back, to pre-recession levels in aggregate.  What these aggregate trends miss are the more granular details by industry, something Bill Conerly advised us recently to examine in a Governor’s Council meeting. Overall, does this mean the U.S. economy is running into some supply constraints and should business investment pick up in the near future as demand increases? Fortunately, the likely answers are yes, and yes.

First, which industries are at least potentially capacity constrained? I examined each of the major sub-sectors since 1980 to gauge at what capacity utilization rate each industry typically began increasing capacity, then looked to see where that industry is today relative to this constrained level of utilization. See the Addendum at the end for more details.

IndProBars

Now, in which industries have we seen actual capacity increase? Just as recession and recovery have been uneven across industries, so too has investment and capacity growth, but by and large, those industries that are constrained are increasing capacity. Note that the vertical axis in the scatter plot is the same as the bar graph above.

IndProContrained

This is good news for the economic outlook as production levels are beginning to reach expansion levels in many of the industries. We’re seeing a supply response in over half of the industries, and outside of Oil & Gas and Computer & Electronics this increase in investment and capacity should continue as demand grows [1].

To date, these increases in capacity appear to be mostly incremental, leaving more room for growth moving forward. This is particularly in the cases of the Chemicals, Fabricated Metals, Food, Plastics & Rubber and Primary Metals industries. Many of these industries can be considered “newly constrained” meaning they are either just around the breaking point in terms of new investment or just reached this level within the past year or so.

The two industries that have increased production (and employment) considerably but have yet to add much to capacity are fabricated and primary metal producers. Should demand for these industries’ products continue to grow, a supply response is likely in the near future. Similarly, many of these “newly constrained” industries should be the main beneficiaries of cheaper energy costs. driven by both increased domestic production and ebbing global prices. While energy intensity is not what it once was, and as energy costs do not make up too large a share of production costs for firms, it should still help, at the very least on the margins.

As for the industries in the lower left hand quadrant, many of these are in longer run structural declines [2].

The industrial production data point to tightening conditions across most industries, but the real question becomes whether or not this next round of investment and expansion will occur in the U.S. In recent years, the tendency has been for increased U.S. demand to be satisfied by increased imports. Domestic industrial capacity did not expand much during the 2000s, as many investments were made overseas. Should this investment pattern continue, the larger manufacturing recovery will have a muted impact on overall U.S. growth.

Thankfully there are a number of reasons to suspect that this time is different. In particular the costs of doing business — namely exchange rates, labor costs and energy costs — are all working in the U.S.’ favor, at least more than they did a decade ago. As some other researchers have noted — Goldman Sachs among them — these advantages may not result in the so-called manufacturing renaissance others have hoped for or even expected. This is true. Typically manufacturers will first look for productivity enhancements before hiring or expanding domestic facilities. However, in a relative sense, it is not unreasonable to expect industrial production and capacity to increase in the coming decade at a better rate than last decade. Growth may not reach the 5%+ growth of the 1990s, but we are already matching the 2.5% growth seen during the 2000s.

Conclusion: Given that the “newly constrained” industries are likely to undergo an expansion in the near future, and provided that expansion happens in the U.S., industrial production and business investment should accelerate in 2014 and 2015. This acceleration in production activity could easily add an additional one half of one percent to GDP growth as well. Seeing corprations and firms reinvest their profits instead of largely leaving them on the sideline will further reinforce the economic expansion, helping provide growth above the lackluster rates seen so far in recovery.

Note 1: Big investments and capital expenditures have been made in natural gas and in oil in recent years, adding to capacity. A slowdown in these investments may be in the works, for this reason alone. As for Computer & Electronics, as we know here in Oregon with Intel, the industry has undertaken a massive expansion in both capacity and new technology in the past couple of years, even as the PC market’s fortunes have waned. Given  investment cycles take years, this industry is unlikely to increase capacity too much further in the near future and may already be trying to rein some of the increases back in, at least until market conditions improve.

Note 2: Industries such as apparel, paper, printing, textiles and possibly furniture, are in more long-run structural declines in terms of domestic production and capacity. These industries — broadly speaking — have not fared well in the past 10-15 years and may not moving forward either. However, other mining activities and wood products are more likely to bounce back. In consultation with our advisors, there is likely to be some new investment in wood products in the near future, although it will likely be concentrated in the South and not the Pacific Northwest.

Addendum: When are industries constrained? Using the author’s estimates I went and examined each of the major sub-sectors since 1980 to gauge at what capacity utilization rate did that industry begin raising capacity itself. I did this a few times and averaged the estimates. Thankfully for most industries the answer each time was the same or very close. Additionally, for many of the industries the answer did not change much over the past 30 years. Even still, these are just one person’s estimates and yours may vary somewhat but this general pattern should still be present.

IndProConstrainedTable

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Posted by: Josh Lehner | February 27, 2014

The Housing Stall

The housing recovery has clearly stalled out in the past 6 months or so. Permits, starts and sales have all leveled off– or worse. The most likely culprits are the continued strong home price appreciation coupled with the run-up in mortgage rates making financing more difficult as would-be buyers experienced sticker shock. The bad weather has certainly not helped either but only impacts the past couple of months. While in the big picture, as Calculated Risk notes this slowdown is expected to prove temporary, it has clear economic implications, in particular at the regional level in the hardest hit housing metropolitan areas. The 50 worst housing bust metros were rebounding faster than average so far in recovery — including Bend and Medford here in Oregon — but we only have good data at the local level through last June, when things were still rosy.

HousingMSA_0613

In terms of housing activity, new permits were growing fastest in these same metros up until last summer when permits decelerated more quickly than the nation overall. Sure, permits can be more noisy but they do eventually translate into actual new construction and economic activity, which is fundamentally what we care about. This slowdown is likely the byproduct of rapidly declining affordability and is more pronounced in the 50 worst housing metros. Not coincidentally, the bulk of these metros are in the West, where recent information from Toll Brothers says they saw the largest declines.

HousingMSA_Permits

To the extent that construction and related activity falters, and slows down economic growth, that’s when it becomes a much bigger concern. Just as the return of housing boosted our regional economies in 2012 and early 2013, the housing stall has effectively stopped these local recoveries [1]. Should this pattern replicated across the country — at it likely is — and the housing stall persists, it will weigh on the economic outlook provided one pillar of growth in the next few years is a strong housing recovery.

HousingMSA_Emp

Thankfully, in the big picture this slowdown is likely to prove temporary. The market should settle as buyers become accustomed to higher interest rates — which should also slow price gains, holding affordability somewhat steady — and increased demand resumes from both a stronger economy (more jobs and income) and a pickup in household formation as demographics are in our favor.

HousingOutlook

The biggest takeaway here is that while our office has long been talking about rural and regional economic recoveries as housing and government turnaround — and we’re certainly seeing that — there are still downside risks involved. The housing recovery should still be multi-year in nature, but there has clearly been at least one hiccup so far and maybe more bumps along the way.

Click here to download the slides in PDF: HousingStall

[1] Given that the Oregon Employment Department does quarterly benchmarking, this data is more trustworthy. Once BLS revises all metro data in March, many of the housing metros are likely to follow a somewhat similar path.

Posted by: Josh Lehner | February 25, 2014

Graph of the Week: Professional & Technical Services

One of the major drivers so far in recovery has been Professional and Business Services as discussed previously. This sector is also expected to outpace all others over the coming decade according to our office’s forecast, plus it carries a lot of weight in the economy as it accounts for 12 percent of all Oregon jobs. Within this employment supersector, the underlying driving force has been Professional and Technical Services — see the Bonus Graph of the Week — which pays nearly 50 percent above the statewide average at $65,000. Needless to say, this industry is a cornerstone to the economic outlook and the Oregon economy moving forward. There’s just one potential problem. In terms of relative size, Oregon’s Professional and Technical Service employment is 20-25% smaller than the national average.

So why does Oregon lag in terms of the relative size of Professional and Technical Services? The following graph shows location quotients by detailed industry for Oregon relative to the nation. A value of 1 means the local employment in that industry is of comparable size to the U.S. average. Oregon has strong employment in the blue bar industries, average concentration in the grey industries and below average employment in the orange industries.

The reason Oregon is below average overall is that many of the orange industries happen to be the largest subsectors; in particular legal, accounting, engineering and computer systems. Oregon strengths in graphic design, veterinary, environmental consulting, architectural and market research are not large enough to offset the relative weakness in those orange industries. Is this a problem for the outlook? By and large, probably not. Many of the orange industries can also be thought of as Big City activities and while Portland ranks as the 24th largest metro, it is not really that big of city. Plus Oregon has a lower share of population in urban areas than the U.S. average. This certainly impacts our industrial structure as seen below.

ProfTech_LQ12

Pile on top of this that the outlook for the legal industry is not so robust as employment is largely stable or declining with slow growth moving forward and if LSAT test takers are a leading indicator, fewer potential workers in the future. This is not to harp on the legal industry — far from it — but given this larger industry is a reason Oregon lags, it is important to examine to see if this will slow the state down moving forward. The one large subsector that is potentially worrisome, to me at least, is computer system and related, which includes a sizable portion of the state’s software employment. Here, Oregon’s relative employment concentration is 40 percent below the U.S. average. This should be a very high growth industry moving forward — and it already is, look at that growth, 47% since 2007! — but the state is starting from a lower relative base. This is also a growth driver in the High-Tech cluster as well.

Overall, while the top line look at the state’s industrial structure for a large industry like professional services may be a little worrisome, once you dig down into the weeds, the picture does brighten. I do think the state (and the region) is pretty well structured for growth moving forward, which is something I’ve been working on and will publish in the next couple of weeks.

Bonus Graph of the Week

Emp_PBSreturntopeak

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