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A review by the Federal Reserve B an k of Chicago Financing the business upsurge 5 Recent trends in state tax legislation: fiscal pressureseasing? 11 The Trend of Business 2-5 Federal Reserve Ba nk o f Chicago OF BUSINESS Despite evidence of a slowing in the rise D uring the third quarter business activity in activity, confidence that the upswing in continued to rise but at a slower pace than business will continue has become increas in the April-June period when the turn ingly widespread. Occasional expressions of around in inventory investment occurred. concern about possible inflation are now Expansion in recent months has been geared heard as demand for both finished goods more closely to final demand for goods on and raw materials rises and new wage in the part of consumers, business and govern creases are negotiated. ment. Wholesale price indexes and prices of most Industrial production rose about 6 per individual commodities which are quoted cent in the second quarter, while during the publicly have not advanced in recent months. third quarter the gain was only about 4 per In September major auto companies indi cent. Wage and salary employment which cated that they would hold the line on prices increased one million from March to June of 1962 models, and aluminum producers showed only a slight further gain in July and reduced prices of ingots from 26 to 24 cents August. Average hours worked by factory employees, which had increased from 38.3 last December to 40.0 Rise in total spending in June, showed very little change projected for fourth quarter during the summer. Although activity continued to billion dollars increase throughout the third +16 gross national product change from preceding quarter quarter, output in some of the industries which led the upsurge, including steel, autos, building materials and textiles, leveled off. Some industries such as farm machinery and television which had increased production sub stantially earlier in the year re ported declines during the sum mer. Output increases in recent months have been centered in ma chinery and a variety of nondura ble goods industries, including chemicals and food processing. B u sin e ss C o n d itio n s, October 1961 a pound. Meanwhile, spokesmen for other basic industries such as steel, farm and con struction machinery, building materials and petroleum continue to emphasize the ex tremely competitive nature of their markets. Any worries that prices will increase on a broad front relate to the future. Rising gov ernment expenditures at both the Federal and state and local levels and new wage agreements adding appreciably to industry costs are cited commonly as possible sources of inflationary pressures. Counter forces, however, are found in the still substantial un used capacity in manufacturing and service industries, unemployment (which remains near 7 per cent of the labor force) and the continued reluctance of consumers to in crease their spending sharply despite higher incomes, increased savings and improved debt positions. M o r e sp e n d in g on ca p ital g o o d s The Government’s survey of new plant and equipment expenditures by business firms released in September confirms earlier projections pointing to a decline in spending in 1961 of about 3 per cent from last year. However, there have been significant shifts in expenditure estimates of various indus tries. Between the second and the fourth quarters it is now estimated that the season ally adjusted rate of capital expenditures will rise by 7 per cent— a sharper reversal of the downturn than had been indicated previously. Most industries are increasing capital ex penditures or at least maintaining them at the reduced level reached earlier in the year. Railroads stand out as an exception; their spending for capital goods continues to de cline. In the fourth quarter the railroads expect to be spending only half as much as in the same period of last year. For 1961 as a whole plant and equipment Steel production rises after summer lull per cent, 1957-59 =100 I960 1961 expenditures of durable goods manufacturers are expected to be off 5 per cent from last year with steel and motor vehicles showing even larger declines. Outlays of nondurable goods manufacturers are expected to be up 3 per cent with chemicals, food processing and petroleum refining accounting for the bulk of the change. Outlays by mining, public utili ties and commercial firms will be about even with 1960. A u to prod u ction a c c e le ra te s After nearly equaling the 1960 level in July, automobile sales dropped 15 per cent in August, relative to the corresponding month last year, and were down further in early September. On the surface the auto sales picture has been very weak in recent weeks with the lowest totals of the past decade except for 1958. Nevertheless, industry spokesmen have indicated satisfaction with the pace of the cleanup of 1961 models and qontinue to express optimism on sales pros pects for the 1962 lines. In mid-September 3 Federal Reserve Ba nk o f Chicago only about 355,000 prior-year cars were on hand, about 40 per cent less than a year earlier. A rash of strikes at one major firm, re sulting from a variety of snags in labormanagement negotiations after basic agree ment had been reached on economic matters, cut deeply into September production sched ules originally projected at over 500,000 units for the industry. Uncertainty as to prospects for the resumption of work at all plants was partly responsible for the failure of steel output to rise further in September. Directly and indirectly, therefore, strikes in the motor industry have had a substantial dampening impact upon over-all business activity in September. Between 1.6 and 1.8 million cars are ex pected to be assembled in the fourth quarter of 1961. The higher figure would be above the comparable period of 1960 and the high est on record except 1955. Inventories of domestically produced new cars may be about one million at the end of the year, about the same as a year earlier. Industry forecasts place domestic auto sales at 6.5 to 7.0 million cars next year, in cluding imports. The higher figure would be second only to 1955. Deliveries during 1961 are expected to total somewhat less than six million, including about 350,000 imports. While a disappointment in some quarters, this figure has been exceeded sub stantially in only three other years— 1950, 1955 and 1960. From late August through mid-September steel output was at an annual rate of slightly over 100 million tons or about two-thirds of current capacity. This rate had been attained for a period of four weeks last spring before the usual summer decline. Aside from the auto industry, which had not begun to order steel at the rate implied by fourth-quarter pro duction schedules, and the farm machinery industry, which had cut back production dur ing the summer, steel demand was described as “good” by industry spokesmen. There was no sign, however, that the step-up in the defense program, expectations of price in creases or lengthening delivery schedules were causing most steel consumers to increase Boost in Government payments holds farm income at high level in second quarter billion dollars billion dollars S te e l ou tpu t rises slo w ly 4 New orders for steel continue to be watched closely as an indicator of the strength of the general business expansion. Through out the summer, customer demands upon the industry have been volatile with slow weeks following weeks of higher orders. B u sin e ss C o n d itio n s, October 1961 inventories. With industrial production cur rently at a record level, steel output at a 100-million-ton annual rate does not suggest appreciable inventory building. If expected orders from the auto industry materialize, steel production may rise to a rate of 120 million tons by year end, or about 80 per cent of capacity. From then on steel demand may be influenced strongly by the possibility of a work stoppage in mid-1962 when the industry’s labor contract expires. Farm incom e h ig h e r Net farm income in the first half of 1961 rose to an annual rate of 12.6 billion dollars —about 12 per cent above the first half of 1960— as crops from the record harvest last year were marketed and farmers cashed Gov ernment checks received for land retired under the feed grain program. In the second half of this year, farm income is expected to remain substantially above year-earlier lev els in view of higher support prices for major crops and dairy products, favorable weather in most major crop areas and increased Gov ernment payments under the various land retirement programs. Despite a roughly 5 per cent reduction in over-all crop acreage, total production of crops this year is estimated to be down only 4 per cent from last year’s record level. Yields per acre are at a new high reflecting good growing conditions and more intensive cultivation of remaining crop lands. While corn acreage was reduced 18 per cent from last year, production—estimated at 3.5 bil lion bushels—is the third largest on record and only 10 per cent below the 1960 harvest. A record crop of soybeans, nearly 30 per cent above last year, is being harvested. High market prices last spring and announcement of an increase in support price caused farm ers to plant 15 per cent more, and the yield per acre is about 10 per cent above the previous record in 1958. Sales of farm machinery were sluggish during the summer even though farm income had risen. The smaller acreage planted to feed grains and severe drought in the North ern Plains apparently have kept the increase in farm income from being reflected in higher demands for machinery and equipment. However, demand is reported to have picked up somewhat in the fall. Financing the business upsurge !^3usiness firms will require a much larger volume of funds if the substantial rise in economic activity generally forecast for 1962 materializes. Capital expenditures, inventor ies and receivables—the principal uses of business funds — are now trending upward and may advance more rapidly in the months to come. Recent surveys indicate business execu tives believe that the current upswing in economic activity will continue for a con siderable period and, for the most part, that their firms will participate in the movement. At present only a modest aggregate rise in expenditures for new plant and equipment and addition to inventories is indicated, with 5 Federal Reserve Ba nk o f Chicago many firms reporting that they do not plan to commit larger amounts of funds to these uses. But surveys of this type typically under state actual developments in periods of gen eral business improvement. Forecasts by Government economists sug gest that gross national product—total pro duction of goods and services—may reach an annual rate of 540 billion dollars in the fourth quarter of this year and possibly 570 billion dollars in the second quarter of 1962. In the July-September period just passed, GNP was estimated to be at a 526 billion dollar rate, up 25 billion from the first quarter. Because of the mildness of the 1960-61 recession and the fact that the recovery began earlier in the current year than in the initial year of each of the other postwar expan sions, 1961 as a whole will show a moderate rise in aggregate activity over 1960. In the comparable years— 1949, 1954 and 1958— total production was slightly below the pre vious year. Official projections suggest that GNP in 1962 will be up about 10 per cent over 1961. This is almost identical with the increases recorded in 1950, 1955 and 1959. In 1950 total corporate uses of funds rose 80 per cent; in 1955, 76 per cent; and in 1959, 30 per cent. Obviously there is no precise rela tionship between changes in aggregate ac tivity and changes in corporate needs for funds. But it seems likely that if the current upswing in business resembles the earlier postwar movements, a substantial increase in funds will be needed to accommodate larger investments in plant and equipment, inven tories, receivables and other assets. Sou rce s a n d uses o f fu n d s 6 During 1961 United States business corporations will receive about 800 billion dollars through the sales of goods and services. (Sales between firms cause this figure to be well above the gross national product.) But they will disperse an even larger amount for wages and salaries, materials and supplies, plant and equipment, tax bills, dividends and other purposes. The additional funds re quired, perhaps 15 to 20 billion dollars, will be obtained from outside borrowing and sales of stock. A useful means of analyzing corporate money needs is provided in the Department of Commerce estimates of “Sources and Uses of Funds” for all corporations other than banks and insurance companies. Generally speaking, “sources” reflect changes in lia bility accounts and “uses,” changes in asset accounts. In the accompanying table, asset accounts are included with uses of funds when they have increased in a given year and with sources of funds when the amount declines. Likewise, liabilities are included with sources of funds when they rise and with uses of funds when they decline. In some years cor porations as a group reduce certain assets such as inventories, cash or Government securities, thereby providing funds which can be used to increase other assets or to reduce liabilities. Similarly, liabilities such as bank loans or income taxes payable may be re duced, thereby using funds. The most important difference from usual balance sheet procedure is that total capital expenditures on plant and equipment are counted as a use of funds, and credits to depreciation reserves are considered a source of funds. Under business accounting prac tice, the change in the capital equipment account shown on the balance sheet is a net figure after deducting depreciation. Total funds applied by corporations in increasing assets or reducing liabilities have B u sin e ss C o n d itio n s, October 1961 Sources an d uses of co rp o ra te fu n d s* 1951 1952 1953 1954 195 5 195 6 1957 1958 1959 196 0 30.8 (billion dollars) U se s 21.6 22.4 23.9 22.4 24.2 29.9 32.7 26.4 27.7 Increase of inventories............................. 9.8 1.3 1.8 S 6.7 7.6 2.1 S 5.7 3.0 Increase of receivables........................... 4.7 5.8 1.1 2.2 11.9 8.8 4.5 6.7 12.2 7.7 Plant and equipment expenditures............ . Increase of cash and Governments............ 2.8 0.1 1.8 — 5.0 S S 2.7 3.6 S Increase of other assets........................... 0.6 0.4 — 0.8 2.8 3.0 1.3 1.9 2.7 2.9 Decrease of income tax liability............... S 3.1 S 3.1 S 1.7 2.2 2.5 S 1.5 Decrease of bank and mortgage loans . . . . S S S 0.6 S S S S S S 33.1 2 8.6 29.1 5 0.6 51.0 4 2.8 40.2 51.9 45.9 T otal.............................................. . . 39.5 So u rc e s Retained profits..................................... . . 10.0 7.4 7.9 6.3 10.9 10.5 8.9 5.7 9.1 7.4 Depreciation.......................................... 9.0 10.4 11.8 13.5 15.7 17.3 19.1 20.3 21.5 22.9 Net new issues of stocks and bonds........... 6.3 7.9 7.1 5.9 6.9 7.9 10.5 9.5 7.8 8.0 Increase of bank and mortgage loans....... 5.4 3.1 0.4 U 5.4 5.4 1.7 1.0 5.3 3.4 4.3 U 0.6 U 3.8 U U U 2.4 U Increase of trade payables .................................. Increase of other liabilities.................................... 2.7 2.7 0.4 U 5.5 5.5 2.4 3 .8 6.8 2.1 1.9 2.4 2.2 0.4 2.1 3.0 2.1 1.7 2.0 1.5 Reduction of cash and Governments................ U U U — U 4.3 0 .3 U U 3.1 Increase of income tax lia b ilit y ........................ . Reduction of inventories........................................... U U U 1.6 U U U 2.4 U U Total ........................................................................ 39.6 33.9 30.4 27.7 50.3 53.9 4 5 .0 4 4 .4 54.9 48.4 < Excludes banks and insurance companies. S = Source. U = Use. N ote: Annual totals do not balance because of statistical discrepancies. varied considerably in the postwar period, although the amount has not dropped below 40 billion dollars in any year since 1955 (see table). Total corporate uses in 1961 may be somewhat below 1960, mainly because of smaller investment in inventories and plant and equipment. B u sine ss in v e stm e n t risin g Corporate capital expenditures on new plant and equipment during 1961 will be about 30 billion dollars, or 3 per cent less than in 1960, according to a recent Govern ment survey. However, the trend has been upward since the second quarter. In the past, upswings in capital expenditures have con tinued for considerable periods and tended to accelerate for a time after the initial stage. To illustrate, a year after the lows reached in 1949, 1955 and 1958 capital expenditure rates had risen 26, 28 and 12 per cent, respectively. The underlying trend in inventories also is upward. Various surveys indicate that business firms plan to increase their inventor ies through the remainder of 1961 and into 7 Federal Reserve Ba nk o f Chicago 8 1962. For 1961 as a whole the rise in inven tories may be considerably less than last year’s 3 billion dollar increase. Inventories declined appreciably in earlier postwar years which marked the beginning of an upswing in business— 1949, 1954 and 1958. In each case a substantial rise occurred in the following year. The current relatively low ratio of stocks to sales suggests that further increases in business activity would be accompanied by a sizable rise in inven tories. Although inventories require large amounts of funds, even larger amounts are needed to carry receivables. During the early postwar years corporate inventories were larger than receivables but by the end of 1960 corporate receivables were 40 per cent greater than the book value of their inventories. Although some portion of this change can be attributed to the adoption of inventory accounting methods which tend to produce book values lower than market values, it reflects primarily the sharp rise in corporate sales on a credit basis. To some extent, corporate trade payables can be viewed as an offset to receivables. But in every year of the postwar period re ceivables of business corporations have risen more than their accounts payable. In the five year period 1956-60 the excess was almost 20 billion dollars. This situation re flects the increasingly important role played by the corporate sector in supplying funds to the rest of the economy through the extension of trade and consumer credit. In years of very rapid credit expansion— 1950, 1955 and 1959—corporate receivables have risen by 12 billion dollars or more and represented the largest single need for funds aside from capital expenditures. Consumer credit, including instalment credit and charge accounts, much of which is extended by industrial corporations and finance compa nies, has grown rapidly during these years. Thus far in 1961 individuals have been spar ing in their use of instalment credit, but any substantial increase in purchases of durable goods would doubtless be accompanied by a rise in instalment credit. Charge account credit, including “credit card” financing, also can be expected to grow with a continued rise in business activity. In te rn a l sources la rg e Funds generated “internally” in the form of retained earnings and depreciation will be at or near a record in 1961. Reflecting the mildness of the recent recession, corpo rate profits declined much less than in earlier periods of business decline and had begun to rise early this year. Meanwhile, deprecia tion continues to increase, although perhaps at a slower rate than a few years ago. Throughout the postwar period retained earnings and depreciation have accounted Rapid rise in corporate receivables since 1953 reflects growing importance of credit sales billion dollars B u sin e ss C o n d itio n s, October 1961 for about two-thirds of all corporate sources of funds. While retained earnings have been volatile, ranging from 13 billion dollars in 1950 to 5.7 billion in 1958, depreciation has risen steadily. In 1946 corporate deprecia tion totaled 4.3 billion dollars. Ten years later depreciation reached 17 billion and in 1960, 23 billion. Large capital outlays during the postwar period and more rapid amortiza tion permitted under the Revenue Act of 1954 account for this increase. Retained earnings have been depressed by the failure of corporate profit margins to hold at the rates of the early postwar years and by the steady increase in the dividend payout from 6 billion dollars in the early postwar years to over 14 billion estimated for this year. The importance of depreciation in the business financial picture can hardly be ex aggerated. While clearly a cost of doing business, corporate depreciation charges do not involve a cash disbursement, as for example, would the rental or leasing of ma chinery and buildings. Being a non-cash charge against income, depreciation funds are thus available to the firm for the purchase of new equipment or other uses. During the current year depreciation allowances proba bly will exceed all other sources of funds by a substantial margin. Although money retained from cash inflow through the depreciation route can be used for any corporate purpose, it is often related to capital expenditures. In the early postwar period depreciation was at a very low level —equal to only one-third of corporate capi tal expenditures. By the mid-Fifties this ratio had risen to about 60 per cent and in the current year it may exceed 80 per cent. C o r p o r a te t a x lia b ility c h a n g e s Since 1950 corporate tax payments have been greatly accelerated under several revi sions to the internal revenue code. Beginning in 1959 corporations have been required to pay up to half of the estimated current year’s tax liability in the second half of the year in which it is incurred. Ten years ago the corpo rate tax liability for a given year was paid in four instalments beginning the following year. The effect of the speed-up in payment of corporate taxes has been to reduce the significance of income tax accruals as a tem porary source of funds to business. In the early postwar years the tax liability on the books at the end of the year was about equal to the tax liability incurred during the year; it is now only about two-thirds as great. In 1959, the last year in which corporate profits rose sharply, tax accruals on the books in creased only half as much during the year as did the tax liability incurred. Se curity sa le s vs. b a n k lo a n s In the first nine months of 1961 business firms sold 8.8 billion dollars of securities for new capital—net of refunding issues. This was 25 per cent more than in the same period of last year and was exceeded only in the first three quarters of 1957. In the second quarter security sales—at 4.7 billion dollars —were especially large. A 965 million dollar equity issue by American Telephone and Telegraph Company and a 300 million dollar debenture issue by the U. S. Steel Corpora tion were included in this total. Even without these offerings second-quarter security sales had been exceeded only once. That was in the second quarter of 1958 which also fol lowed a period of declining business activity. Raising long-term funds in these periods tends to defer an increase in bank loans as business begins to expand. As in the initial stages of previous periods of rising activity, business loan demand at commercial banks has not increased signifi- Federal Reserve Ba nk o f Chicago cantly in recent months even though indus trial production has risen. At the end of July commercial and industrial loans at weekly reporting member banks of the Federal Re serve System were 850 million dollars less than at the start of the year. Modest loan growth did occur in August and September, but perhaps less than might have been ex pected seasonally even in the absence of a vigorous rise in economic activity. Commercial loans of banks seldom in crease substantially in the first six to nine months of a business upturn but usually rise rapidly thereafter. The largest yearly in creases in bank loans to business, 3.5 billion dollars or more, during the postwar period occurred in 1951, 1955 and 1959—each of these years being preceded by a considerable period of rising activity. The fact that interest rates on prime com mercial paper this year have averaged more than 1V2 per cent lower than the prime rate on high-grade business loans at banks has encouraged business firms and finance com panies to obtain a greater proportion of their financing needs from privately placed com mercial paper than in the past. During the first half of 1961, when business loans of banks declined, commercial and finance com pany paper outstanding rose by over 300 million dollars. Econom izing on cosh 10 Although corporate holdings of liquid assets—mainly cash and Government securi ties—have tended to rise during the postwar period along with other corporate assets and liabilities, there has been a fairly steady de cline in corporate liquidity when compared with current liabilities. At the end of 1946 corporate holdings of cash and Governments almost equaled total current liabilities. By 1955 the ratio of cash and Governments to C o rp o rate depreciation and capital outlays have risen much faster than retained earnings billion dollars current liabilities had dropped below 50 per cent and by the end of 1960 it was down to 37 per cent.1The rather gradual decline in the liquidity ratio in recent years possibly indi cates that this means of reducing over-all corporate needs for funds has largely been exhausted. In recent years the large need for funds, coupled with the generally higher level of interest rates, has greatly enhanced efforts on the part of corporate treasurers to achieve more efficient cash management. A number of practices have contributed to this end, including attempts to accelerate collections of receivables and deposit of receipts from cus tomers, closer management of multiple de posits and tailoring maturities of short-term investments to coincide with needs for funds, e.g., tax and dividend payments. The effort to utilize liquid funds effectively in large T o some extent corporate liquidity is under stated because other near money assets, principally commercial paper, are not usually included in this ratio. B u sin e ss C o n d itio n s, October 1961 firms requires continuous analysis of cash inflow and outflow. Although corporate bank deposits were near an all-time high at the end of 1960, there has been a steady decrease in the amount held relative to the volume of busi ness in the postwar period. Corporate sales in the fourth quarter of 1960, on an annual rate basis, were 20 times as great as cash on hand at the end of the year. Five years earlier this ratio had been 17.6 while at the end of 1946 it was 12.4. Su m m a ry As yet there has been very little increase in total business needs for funds although the business expansion has been under way since early 1961. If the pattern of the past is re peated, however, and business activity con tinues to rise, a substantial increase in the amount of funds needed by business firms will develop in the next several months. As in 1958, corporations this year have taken advantage of easier capital markets to float a large volume of new issues. And, as in earlier postwar business expansions, business loan demand at banks has lagged the rise in activity. Requirements for corporate funds from the capital and money markets in the months to come will depend primarily upon two re lated factors. First, the extent of the rise in business activity and, second, the extent of the improvement in corporate profits. Since dividend pay-outs tend to rise very gradually, a surge in profits would be reflected largely in higher retained earnings and thus reduce dependence on outside sources of funds. Recent trends in state tax legislation: fiscal pressures easing? further hike in state tax revenues is in prospect. Legislative sessions held this year in 47 of the 50 states resulted in a wide variety of changes in tax rates, including re definitions of tax bases, adoptions of new kinds of taxes and some reductions and abandonments of taxes. The net effect of these measures is estimated to boost total state revenues about 6 per cent—from 19.2 billion dollars in the fiscal year ending in June 1961 to 20.3 billion in the current fiscal year. Actual collections, of course, are likely to exceed the estimated amount since the yield of state tax measures depends upon several factors in addition to tax rates and specifications of what is taxable. Among these are the level of retail sales, personal and business income, cigarette and liquor consumption and the intensity of highway use. The current rising trend in business, if maintained, will help to raise revenues above estimated levels. In th e District . . . Of the five Seventh District states, Illinois made the most far-reaching changes in its tax 11 Federal Reserve Ba nk o f Chicago system during the recent session of its legis lature. The basic sales tax rate was raised from 3 to 3V2t per cent, and the definition of taxable transactions was broadened to cover several types previously excluded. The rate applicable to certain of the newly covered transactions was set at 3 per cent rather than 3 Vi per cent. Sales of books, magazines, records and materials used in construction, however, were made subject to the 3 Vi per cent tax. Including the permissive Vi per cent local tax in effect in most parts of the state, the Illinois rate now is equaled in only four of the other 35 states having a retail sales tax. The temporary one cent addition to Illinois’ three cents a pack tax on ciga rettes, an increase adopted in 1959 specifically to finance bonuses for Korean veterans, was made permanent as a source of general revenue. In Wisconsin the cigarette tax was raised from five to six cents per pack. A bill levying a new 3 per cent sales tax was vetoed by the Governor. The legislature, in recess since August 12, is scheduled to reconvene late in October when it is expected that further attention will be given to revenue matters. Neither Iowa nor Indiana made any material M e a su rin g state tax changes in 1959 and 1961 Fiscal 1959 tax collections Actual If 1960 taxes had applied1 Fiscal 1961 tax collections Actual If 1962 taxes had applied1 Per cent increase 1959-60 1961-62 11 (billion dollars) Consumption taxes 5.9 6.7 7.2 8.0 13 General sales 3.7 4.1 4.5 5.1 11 13 Tobacco 0.7 0.9 1.0 1.1 32 11 Alcoholic beverages 0.8 0.9 0.9 1.0 15 5 Other 0.7 0.8 0.8 0.8 7 5 Personal income taxes 1.8 2.1 2.3 2.4 20 3 Highway user charges 4 .6 4.8 5.0 5.3 5 4 Gasoline taxes 3.1 3.3 3.4 3.6 7 4 Licenses 1.5 1.5 1.6 1.7 2 3 Corporation income taxes 1.0 1.1 1.3 1.3 8 6 O ther business taxes 1.7 1.8 2.0 2.0 6 4 All other 1.1 1.2 1.4 1.4 3 2 16.1 17.7 19.2 20.4 10 6 Total 'Estimated by applying rate increases to the prior year’s receipts; effects o f new taxes and changes in bases are state estimates. 12 B u sin e ss C o n d itio n s, October 1961 changes in their tax systems this year. Michi gan discontinued several “temporary” rev enue measures but raised the sales tax rate one point to 4 per cent in January. The effects of 1961 legislative action upon the tax revenues of the Seventh District states, again without attempting to give effect to changes in economic activity are estimated as follows: Dollar change (millions) Per cent change + 136 0 0 — 37 H~ 5 + 16 0 0 — 4 + 1 Illinois Indiana Iowa Michigan Wisconsin M a jo r c h a n g e s in o th e r sta te s Texas this year adopted a sales tax; Ken tucky, which holds biennial legislative ses sions in the even-numbered years, had adopted such a tax in 1960. These actions increased to 36 the number of states using a sales tax. West Virginia, the first state to adopt the sales tax—in 1921— added the income tax to its fiscal machinery in 1961. New Jersey also adopted a limited personal income tax this year; the tax is restricted to incomes earned out-of-state by residents and in New Jersey by nonresidents. Taxes on net income—personal, corporate or, most commonly, both — now are levied by 37 states. Virginia’s adoption of a three cent a pack cigarette tax in 1960 left only three states—Colorado, North Carolina and Ore gon—in which this tax is not used. Rate advances and enlargement of bases under existing taxes, of course, have been more widespread than adoptions of new kinds of levies. Four states hiked their sales tax rates; five materially broadened the list of transactions taxable under their statutes. Income tax rates were increased by five states and reduced by two. Gasoline tax rates were raised by six states— all 50 employ this tax —while cigarette tax rates were increased in 16 states and reduced in one. S m a lle r in c re a se th a n in 1 9 5 9 Two years ago the revenue increase im plied by legislation affecting state taxes was 10 per cent, considerably more than this year (see table). Is this an indication that the spending pressures confronting the states are beginning to abate somewhat, or does it merely mean that actions taken in 1959 pro duced enough additional revenue to permit some “catching up”? Some intimation that the latter is true is provided by the abrupt shift from deficits to surpluses after fiscal 1958. For nine consecutive years, 1950 through 1958, annual general expenditures of the states appreciably exceeded general revenues, culminating in a deficit of 2.4 bil lion dollars in fiscal 1958. The following year a 193 million dollar surplus was re corded, and this was followed by a still larger one— 550 million dollars—in fiscal 1960. The recent increase in cash balances held by the state governments may be another indication of easing financial pressure. In 1954 deposits and securities on hand other than those earmarked for insurance trust accounts and bond sinking funds were equiv alent to seven months’ general expenditures. Five years later, at the end of the fiscal year in which the numerous tax changes of 1959 were made, the ratio was down to 4.6 months. By the end of fiscal 1960, however, it had moved up slightly to 4.9 months, no doubt reflecting at least in part the far-reaching modifications in tax programs that took effect that year. The 1961 legislative record also reveals that some of the states—California, Con- 13 Federal Reserve Ba n k o f Chicago necticut, Illinois and Pennsylvania, for ex ample—plan to lean more heavily upon borrowing as an alternative to pay-as-you-go in the financing of capital outlays. Expecta tions of a larger measure of Federal aid may well be another influence tending to moder ate prospective budgetary pressures and therefore working to lessen somewhat the need for increased state tax revenues. Some observers contend, however, that state revenue systems will remain under pressure. They suggest that further upgrading of service standards and enlargement in the range of services provided will require more revenue than existing tax rates and tax forms appear likely to provide. To the extent that property tax revenues grow less rapidly than the demand for serv ices and facilities provided by the local governments, municipalities will require in creased state support for public education and other local governmental functions. Local tax revenues tend, of course, to grow more or less automatically as construction adds new property to the tax base. Because, however, of the segmented nature of the local Income sources of the Seventh District state governments: fiscal 1960 A ll states Illinois Indiana (millions) General tax revenues Consumption taxes Michigan Iowa $18,257 6,864 $836 522 $399 220 $277 106 $943 476 $426 48 4,302 375 189 81 363 — Tobacco 923 49 17 11 54 21 Alcoholic beverages 871 32 15 768 66 14 * 51 Other 14 * — 222 General sales Personal income taxes Highway user charges 2,209 4,908 — — 247 139 37 106 8 12 139 116 Gasoline taxes 3,335 142 101 60 146 72 Licenses 1,573 105 38 46 76 44 _ 174 71 59 14 50 Corporation income taxes Other business taxes All other taxes Other income from state sources Federal aid Total state revenues Net long-term b orrow ing Total a v a ila b le 14 Wisconsin (millions) 'Less than $500,000. 1,180 1,408 1,688 41 26 20 20 4 10 14 3,853 6,382 81 338 92 128 97 121 296 217 64 117 28,492 1,255 619 495 1,456 607 1,505 8 1 2 47 18 29,997 1,263 620 493 1,503 625 B u sin e ss C o n d itio n s, October 1961 governing units, addi tions to the tax rolls and increases in expen diture often occur in different places. The hard-pressed govern mental bodies there fore are prompted to look to the states for financial assistance. A tu rn in g p o in t ? Income and general sale s ta x e s have become increasingly common features of state revenue systems Number of states using Per cent of all tax revenues Fiscal 1947 Fiscal 1961* Fiscal 1947 Fiscal 1961 General sales taxes 24 36 20 24 N e t income taxes 33 37 15 19 16 24 35 43 32 47 4 5 Both Cigarette taxes While there is evi 9 Alcoholic beverage taxes 50 50 5 dence that spending 4 50 50 5 Other selective sales taxes pressures continue to Business licenses, etc. 50 50 7 10 grow rap id ly th e re 50 28 Highway user charges 50 26 nonetheless is some 50 50 12 7 A ll other in d ic a tio n th a t the Total tax revenues 100 100 period of critical pres *As of September 1, 1961 sure on state budgets may be passing. The key here is in the changing pattern of population growth. During the past 15 the huge numbers of children born in 1941 years, young persons and the aged have ac and 1942 and since 1945 pass the 20-year counted for the great bulk of the growth in mark. As these people enter the labor force the nation’s population. Programs serving and succeed in finding suitable jobs, personal income and consumer expenditures will pro chiefly these segments of the populace tradi tionally account for a big share of all state bably rise at a faster pace than in recent government expenditure. Total outlays by the years. This, in turn, should generate an “automatic” expansion of state revenues states for public education and aid to de pendent children (programs serving young more nearly matching the rising volume of people for the most part) and for old-age public expenditures geared to over-all popu assistance and hospital services (directed lation growth. mainly toward the aged population) in 1960 S ta n d a r d iz e d sta te t a x e s ? amounted to 13.2 billion dollars or nearly half of the 27.2 billion in general expendi The 1961 legislative season brought to 24 tures. the number of states using taxes on both Although the numbers of children and the incomes and retail sales. Fifteen years ago, elderly are expected to increase further in only 16 states employed both of these levies. the years ahead, this growth will be accompa This development along with the more gen nied by a faster rise in the numbers of people eral use of other tax measures suggests a from age 20 through 64. This will occur as trend toward diversification of state revenue — — 15 Federal Reserve Ba nk o f Chicago P o stw ar rise in state spending has outstripped revenue growth — Federal aid and borrowings have filled gap Billion dollars Per cent 1947 1953 1960 1947 1953 1960 7.3 12.9 22.1 80 79 74 W h e re the m o n e y cam e fro m Revenue from state sources Federal aid 1.4 2.6 6.4 15 16 21 N e t long-term borrowing 0.5 0.8 1.5 5 5 5 92 T6~3 300 Too Too Too 45 To ta l* W h e re the m o n e y w e n t Operating expenses 3.6 8.0 13.2 51 50 Capital outlays 0.9 2.8 6.6 12 17 23 Aid to local units 2.6 5.4 9.3 37 33 32 7.1 16.2 29.1 100 100 100 Total •Excludes trust fund transactions and changes in cash balances. 16 systems. While some states—Illinois is an example—have tax systems based predomi nantly on retail sales, others—like Wisconsin —rely predominantly on income taxes. But the number of such states has been declining. It may be significant that in 1961 a sales tax measure was passed by the Wisconsin legislature, while several proposals for in come taxes were actively considered in Illinois. The extent to which a state can exploit any given kind of tax often is limited by the practices of other states which “compete” with it as a site for new industrial develop ment. Substantial differences between income or sales tax rates on the two sides of a com mon border may well constitute a deterrent to further increases by the state having the higher rates as well as an invitation to the neighboring state to raise its rates. If spend ing pressures continue strong, the individual states may well move further in the direction of diversification of their revenue systems, with the types and levels of taxes tending to become more or less uniform. Business Conditions is th e fe d e r a l r eser v e p u b lis h e d m o n th ly b y ba n k o f Ch i c a g o . Sub s c r ip tio n s a re a v a ila b le to th e p u b lic w ith o u t ch a rg e. F o r in fo rm a tio n c o n c e rn in g b u lk m a il in gs to b a n k s, b u sin e ss o rg a n iz a tio n s a n d e d u c a tio n a l in s titu tio n s, w rite : R e se a rc h D e p a r t m e n t, F e d e ra l R e s e r v e B a n k o f C h ic a g o , B o x 8 3 4 , C h ic a g o 9 0 , Illin o is. A r tic le s m a y b e r e p r in te d p r o v id e d so u r c e is c r e d ite d .
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