Sharp Decline In Withholding Tax Receipts Signals Imminent Recession

by: Erik McCurdy

The forward indicators that produce the most reliable signals with respect to recession forecasting continue to indicate that a return to economic contraction is highly likely in early 2012. Our computer models have been predicting the likely start of a new recession in the US for the past several months and the data trends continue to weaken as we approach the end of the year, suggesting that the recession scenario is becoming even more likely.

One indicator that has weakened significantly during the last two months is the trend in federal withholding tax deposits. Economist John Williams of Shadow Government Statistics discussed the deterioration in this data set in a recent commentary.

A sharp downturn in the annual change in withholding tax receipts by the U.S. Treasury is signaling a deterioration in personal income. The shift in tax revenues began to surface in Treasury reporting of October 2011 and has continued through the latest available numbers, as of December 7th.

Although the relationship between employment, income and these tax receipts is a complex one, essentially, one would expect to see the year-to-year change in the tax receipts run in parallel to the year-over-year change in total payroll earnings (jobs times average earnings), as estimated by the Bureau of Labor Statistics (BLS). This was the case during most of 2011, but, starting in October, a divergence developed: Whereas year-to-year change in BLS estimated payroll earnings continued at a more-or-less constant, positive level, tax receipts fell quite markedly.

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The sharp decline in withholding tax deposits that began in early 2011 is gaining momentum as we move into 2012 and this type of material deterioration was accompanied by economic contraction when it occurred in 2001 and 2008.

As always, there are no certainties when it comes to financial market forecasting, only possible scenarios and their associated probabilities. However, the vast majority of historically reliable indicators continue to signal that the development of a recession is highly likely, so we will remain defensive until provided with compelling evidence to the contrary.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.