US corporate profits forecast to fall over next 10 years from their current 40-year high level

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US corporate profits forecast to fall over next 10 years from their current 40-year high level
By Finfacts Team
Aug 18, 2006, 13:00

The US Congressional Budget Office said on Thursday that receipts from corporate income taxes will rise by 22 percent in fiscal year 2006 to $340 billion. That rise reflects the growth of before-tax corporate profits, which are expected to increase by about 30 percent this year. After three years of strong profits, corporate tax receipts as a share of GDP are at levels not seen since the late 1970s.

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Source: CBO

The CBO says that after rising sharply for the past three years, revenues from corporate income taxes are projected to decline gradually as a share of GDP over the next 10 years: from 2.6 percent in 2006 to 1.7 percent by 2013—a level similar to that seen in the early 1990s.

That decline mainly results from CBO’s forecast that corporate profits will grow more slowly than GDP after this year. Profits are projected to decrease from about 13 percent of GDP in 2006 to about 9 percent in 2016.

The taxable profits of corporate America will fall 8 per cent next year and remain on a downward trajectory until 2010. The CBO estimates that total taxable profits will inch up in 2008 but fall again in 2009 and 2010, and will not recover their current level in nominal cash terms for almost a decade.

The recent growth in corporate tax receipts relative to GDP, reflects profits’ reaching new highs relative to the size of the economy. CBO expects that over the 2007–2016 period, both profits and receipts will return to levels more consistent with their historical relationship to GDP.

Economic profits, at more than 12 percent of GDP in the first quarter, are at their highest level in 40 years and significantly above the post-World War II average of 9.4 percent of GDP. Even though the level of profits might decline for several reasons (higher required contributions by firms to employee pension plans under the Employee Retirement Income Security Act and increases in wages, depreciation, and interest costs), economic profits should be ample to fund much of the increase in business investment that CBO forecasts.

A relatively low cost of funds also supports CBO’s current outlook for business investment. In recent years, corporations’ liabilities have dropped significantly relative to their assets, and at 45.1 percent in the first quarter, that ratio was the lowest in roughly two decades, indicating strong financial positions. The risk premium (the extra cost for private-sector borrowing, measured relative to the rates on government securities) has fallen consistently since 2002. The real cost of corporate borrowing, which reflects those factors, is expected to remain near its current level, which is close to the average for the post-World War II period. Similarly, there has been little increase in the real cost of raising funds through the equity markets.

The CBO sees a modest increase in the labour share of national income, with wages and salaries rising from 45.0 per cent of GDP to 45.9 per cent four years from now.

This reflects an assumption that employee compensation, broadly measured, will rise more rapidly at about 3.3 per cent annually in the coming years, compared with 2.5 per cent last year and 2.9 per cent this.

Donald Marron, acting director of the CBO, said on Thursday that much of the spectacular rise in corporate profits in recent years had been attributable to falling investment (and therefore lower depreciation) and reduced interest charges. Both these factors are now swinging into reverse, with depreciation and interest charges set to rise significantly.

US federal deficit

The CBO says that if no further legislation is enacted that affects spending or revenues in 2006, the federal deficit will fall to $260 billion (2.0 percent of GDP) this year from $318 billion (2.6 percent of GDP) in 2005. Total outlays are projected to grow by almost 8 percent from last year’s level, but total revenues will grow faster: by nearly 12 percent. Although lower than the increases in 2005, those growth rates are well above the averages of recent years.

On the basis of tax collections through July, CBO anticipates that federal revenues will rise sharply in 2006 for the second year in a row. After growing by 14.5 percent in 2005, total revenues are expected to increase by 11.6 percent or $249 billion⎯this year to just over $2.4 trillion.

Those percentage increases are the highest in the past 25 years. As a share of GDP, revenues are expected to rise from 17.5 percent in 2005 to 18.3 percent this year, slightly higher than the 18.2 percent average of the past four decades.