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Can the U.S. Economy Hold Up?

There's still a good chance it could. In a chaotic world, the U.S. remains a rock of stability. But the risk is rising that America, weighed down by mounting troubles abroad, will finally see its long boom end.

by Justin Fox

Is America headed for a recession? It better not be, because for the rest of the world, the resilient growth here and in Europe is just about all that's been keeping things from going from bad to much, much worse. The soothing party line from Wall Street's gurus, of course, has been that "supertanker America," as Goldman Sachs strategist Abby Joseph Cohen famously put it last year, will have no trouble navigating difficult global seas. The Asian depression, the Russian collapse, and the stock market's recent slide have simply taken some steam out of an economy that was in danger of overheating.

If the stock market carnage at home and economic pain abroad don't get any worse, the optimists will turn out to be right. But when Fed Chairman Alan Greenspan says that "it is just not credible that the U.S. can remain an oasis of prosperity," somehow their argument is no longer as reassuring as it used to be. If there's one truth to be gleaned from the rolling global financial crisis that began last summer, it's that however bad the situation in the world's emerging markets already looks, it can get worse. China and Latin America could finally get sucked into financial chaos; Western Europe's economies could falter under the pressure of emerging markets' panic; the Dow could drop another 1,000 points or so. If that happens, the U.S. economy may no longer be able to shrug off the world's troubles. "You can spin a story very easily for a recession, probably starting at the end of 1999," says Kurt Karl, chief economist of the forecasting firm WEFA.

Up until now America has been a bastion of economic strength in a world desperately in need of it. The current U.S. economic expansion is already the third-longest ever, and in December it should move up to No. 2 on the list. Unemployment is the lowest it has been since 1970. Consumers are spending up a storm, business investment is strong, and government finances are in their best shape in decades.

Since nobody ever really knows what the economy's going to do next, there's a lot to be said for just assuming that it's going to keep doing what it's been doing for the past 90 months--that is, growing. That's likely to be the call the Federal Reserve makes Sept. 29, when its Federal Open Market Committee meets to decide what to do about the short-term interest rates it controls. Most Fed watchers expect that it will simply do what it has done since March 1997--leave rates alone.

But there's been a fundamental change since midsummer. Back then the biggest risk to the economy was that low unemployment and high consumer demand would bring on inflation. The minutes of its early July meeting indicate that the Fed was seriously thinking about a rate increase to cool the economy. That's why financial markets used to react negatively to "good" economic data like low unemployment or high demand--they were afraid the Fed would have to crack down.

No more: Now the what-ifs bandied about by economic forecasters all show growth fizzling, not getting too strong. The economists at WEFA, for instance, have dropped their 1999 GDP forecast from 2.6% to as little as 2%. They have also constructed an alternate scenario for a 1999 recession, which they figure has a 35% chance of occurring. Standard & Poor's DRI, which is predicting 1.5% GDP growth in 1999, has a similar recession scenario.

The pessimistic scenario goes something like this: A continued slide in stock prices could dampen the "wealth effect" from stock market gains that has fueled the economy in recent years. Standard & Poor's DRI chief economist David Wyss figures the $2 trillion in stock market capitalization lost between July 17 and the end of August should translate into a $50 billion cutback in consumer spending, which would reduce GDP by about half a percent. Further market drops would cut GDP more, of course. Meanwhile, weak demand from abroad is already reducing exports--which dropped 8% in the second quarter. Exports make up only 13% of U.S. GDP, but they've been a big factor in economic growth in the 1990s. Reduced exports and weaknesses in multinationals' foreign operations also could cut into profits, and lowered profit expectations would lead corporate America to cut back on capital spending, another driver of GDP growth in recent years. Dimming prospects would also lead companies to lay off workers, further decreasing consumer spending. And weak corporate profits could bring further declines in stock prices, which ... well, we've already shown what that can do to consumer spending.

Put it all together, and you could get a downward spiral into a recession. So far only a few elements of this scenario are in place--the stock market has dropped, exports are down, and corporate profits are slumping, but many other economic indicators, such as employment and manufacturers' orders, are still strong. Wyss says that what would tip the balance is more bad news from abroad--a currency devaluation in China is his chief fear.

A recession isn't the end of the world--the U.S. economy has survived 21 of them this century. But a U.S. recession coming when much of the world is mired in an outright economic depression could be messier and more prolonged than usual. Without strong demand from American consumers, Japan and other Asian countries would be even worse off. True, Western Europe, the world's other bastion of economic strength, is less susceptible to a "wealth effect" downturn than the U.S.--Germans, for example, have only 8% of their financial assets in the stock market, compared with Americans' 39%. But Western Europe is a lot closer to Russia and its imploding economy. "Russia and Eastern Europe were a rapidly expanding part of our trade," says Deutsche Bank chief economist Norbert Walter, who is cutting his 1999 GDP growth forecast for Germany from 3% to 2%.

Who Pays What?
Destroying the Myth of the "Decade of Greed."

The left just loves to refer to the Reagan years ad the "Decade of Greed." The implication is that higher income types got away with absolute murder during the '80's when it comes to paying income taxes. Well, let's take a look at some statics from the Internal Revenue Service to see just what the various income levels were paying in income tax in 1981, and what they were paying in 1991.

1983 -- The beginning of the decade of greed - The year the Reagan tax breaks took effect.

Here we find the top 1% of all income earners in the United States paying a total of 20.3% of all of the personal income taxes collected by the IRS. The top 10% were paying 49.7% of all income taxes, and the top 50% was paying 92.8%. The bottom 50% of all income earners were paying only 7.2% of all income taxes.

1993 -- The decade of greed ends! Clinton raises taxes to the evil rich will pay their fair share!

Ten years later, in 1993, we find the top 1% of all income earners paying 28.7% of all income taxes collected! Wow! Those rich guys really got away with murder, didn't they? The top 10% saw their share of total income taxes collected go from 49.7% to 58.8%. The greedy so-and-so's. The top 50% saw their share rise to 95.2% of all taxes, while the bottom 50% saw their share drop from 7.2% to 4.8%.

It's 1998 --- How are the exploiters of the poor doing now

The September 23, 1998 issue of The Wall Street Journal has the new numbers for us. The share of the taxes being paid by the top 1% has gone up again! For the year 1966 they are approaching 33%.

Yeah..But those rich bastards are earning so much they still weren't paying their fair share.

OK, fine. What would you consider a fair share? If the top 10% was earning 70% of all the income but only paying 58% of the taxes, that wouldn't be fair, would it? Well ... let's see what the figures show.

In 1993, at the end of the Decade of Greed, the top 1% were paying 28.7% of all taxes. They earned only 13.8% of all earned income. Oops! sounds like they are paying a bit more than their fair share, doesn't it? What about the top 10%? They were paying 58.5% of the income taxes but earning only 39% of the income. The top 50%? Paying 95.2% of the taxes, earning 85% of the income. The bottom 50%? Earning only 15% of the income but paying just 4.8% of the income taxes.

Update ... In 1996 the share of the income earned by the top 1% reached 16%. Remember: They're paying one third of all the taxes.

So ... who is getting away with not paying their fair share? Looks like the bottom 50% to me ... not the evil, hated, mean, nasty, wicked rich.

These figures came from The Tax Foundation and IRS Statistics, 1983 through 1993. You go and do your own research and verify them! Then tell me just what the hell Bill Clinton was talking about when he said that the rich need to pay "their fair share."

Excuse me ... I have to go throw up.

This letter is in response to your inquiry concerning family limited partnerships as a vehicle for estate planning. You have indicated that you hold a large amount of appreciated securities and would like to begin transferring these assets to your children.

Family limited partnerships are being used to achieve significant tax savings in the area of transfer taxes (i.e., estate and gift taxes). The partnership is used as a mechanism to divide family assets among family members to take advantage of rules permitting reduced valuation of the amount being transferred for transfer tax purposes. The reduced valuation is the result of a discount applied to partnership interests because of the limited partner's lack of control over the partnership and the resulting lack of marketability of that interest. Generally, because limited partners have no right to participate in the partnership's management, a buyer will pay less for a noncontrolling interest in a partnership than for outright ownership and control of the underlying assets. As a result, the value of the limited partner's interest is reduced accordingly.

While family limited partnerships have historically been used to hold family real estate and operating businesses, a 1993 IRS ruling and a subsequent technical advice memorandum have indicated that the IRS will allow a minority discount for a transfer of an ownership interest in an entity to a family member even where the aggregate ownership interests of all family members provide them with control of the entity at the time of the transfer. In your case, the securities could be transferred to a limited partnership and small percentages of the limited partnership interests can be gifted to your children each year free of gift tax. You and your wife (or another family member) would remain the general partners, thereby assuring your control over the partnership and its assets.

For example, assume you and your wife wish to begin gifting $2,000,000 in appreciated securities to your three children. The annual exclusion and spousal gift-splitting permits an annual gift of $20,000 to each child or an aggregate of $60,000 of securities each year without gift tax consequences. Instead of gifting the securities outright, you would contribute them to a limited partnership and each take back a 1% general partner interest and a 49% limited partner interest. Each year, your wife and you could gift a limited partnership percentage to each child. If a valuation discount of one-third can be justified for the limited partner interest, a 1.5% limited partnership interest can be gifted to each child each year. An interest allocable to $30,000 of family limited partnership assets (1.5% of $2,000,000) would have a $20,000 gift tax value. Thus, gifts of interests allocable to $90,000 (rather than $60,000) of securities could be transferred each year, fully covered by the gift tax annual exclusion. This also, of course, removes these assets from your estate so that they will not be subject to estate tax when you die.

Family limited partnerships may also be used as a means of protecting assets from creditors. If the transfer of assets to a family limited partnership does not violate applicable fraudulent conveyance rules, the creditors or bankruptcy trustees generally can not reach the assets transferred. Even though a creditor could seek a "charging order" against a limited partnership interest, the creditor may risk being treated as the taxpayer with respect to profits and losses allocated to the partnership interest. In such cases, the creditor may be taxed on "phantom" income with no assurances as to when distributions of cash would be made to cover the taxes due on such income. A creditor may instead wish to engage in negotiations which result in a favorable settlement to the debtor.

Because each family situation is different, I would like to meet with you in person to discuss the various options that may be available and appropriate in your circumstance.

Sincerely,