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Thursday, January 5, 2012

What Do Jobless Claims Tell Us About Nonfarm Payrolls?

With a very strong ADP number this morning, some are wondering if tomorrow's jobs report could be a blockbuster.  There's a good chance it could be fairly decent given the recent trend in jobless claims.

Here's the relationship between the two since January 2004:

That there is a relationship between these two is not a surprise as they have a very strong intuitive link.  However, the relationship is clearly not consistent as there have been months where jobless claims average 500,000 a week and yet jobs changes were near the flat line. Similarly, we have had months with net job losses where jobless claims have averaged less than 400,000 a week for that month.  Coming off of the recession, it seems that we can generate net increases in jobs at relatively high levels of jobless claims. In the past month, jobless claims have averaged 375,600, the lowest May of 2008, which was actually a time when we lost over 200,000 jobs.  On the flipside, we had a month in February of 2011 when jobless claims averaged 392,500 and nonfarm payrolls grew 235,000.  Go figure.

The basic reason is that the change in nonfarm payrolls is the residual of the massive amounts of gross job gains and losses that occur each month.  Millions of jobs are created and eliminated every month.  Jobless claims are effectively a measurement of gross job losses.  As we enter recession, the offsetting gains diminish and thus we can lose fairly substantial amounts of jobs even at apparently benign levels of jobless claims.  The inverse is true as well.  The question is always "Which part of that slope are we on?".  At this time, we appear to be at a time with accelerating gross job gains that are allowing us to have substantial net job creation even close to the 400,000 level in jobless claims.  As such, it is quite likely that we actually will see net private sector job gains of over 220,000 in the report tomorrow.  Government losses will offset that amount to some extent, but overall it should be a decent report.

A Simple Discussion on Deductions and Exemptions

As someone who works in the tax policy field, I understand where the frustration comes from when people look at the massive schedules of deductions available to both individual taxpayers and businesses.  As such, since tax code simplification is a popular subject these days, some just throw up their hands and say, "Get rid of them all and tax every dollar of income!".  It's an emotionally appealing argument in times like this, but let's remember some theoretical bases behind why we set up the tax code the way we did.

First, I would like to remind people of how businesses are taxed in this country.  Except in a few states where either gross receipts taxes or some form of value added tax exist, businesses are taxed on their net income.  Net income is a defined term that doesn't correlate with cash flow, except in some cases by accident.  For tax purposes, it is the business' gross receipts - deductions for various expenses or bonus deductions for certain activities.  As a general rule, though, the idea is to impose a tax on what is available to the business after it has paid for all of its normal operations.  Businesses not keeping their heads above water don't play taxes.

The same principal is applied in a different way to individuals.  Individuals do not have a "net income" as we commonly understand it.  Individuals have a great deal of latitude in how to incur expenses and pretty much anyone can expand their expenses to fit any income.  However, there are certain minimums that people can't go below and this is the basis of the baseline deductions and exemptions.  A certain amount of income will not be subject to tax in order to allow individuals to pay for baseline expenses without having to pay taxes.  This is to avoid taxing beyond their ability to actually pay their bills.  The effect is to try to create a parallel to business net income for individuals and in so doing not taxing them beyond their ability to pay.

I would be the first to admit that we have far too many specialized deductions and credits that serve very particular interests or that have outlived their usefulness, but to simply rid the tax code of deductions and exemptions is not the answer.  It doesn't even make good theoretical sense.  The reason that more and more people are falling of the tax rolls is because the indexing of exemptions and deductions continues to push people with stagnant nominal incomes below zero taxable income. What this reflects is that the cost of living is accelerating faster than their ability to pay.  Simply deciding to redefine the boundaries of the tax system to have those people pay more in taxes doesn't seem to make logical sense.