# How to calculate capital income’s consumption rate for recession forecasting

During the posts about the percentage rate of capital income used for consumption, it seemed readers were not sure how I calculated the number. Well, I want to show here how I calculate the percent of capital income used for consumption. The number is currently rising from quarter to quarter. When it begins to fall, a recession is appearing on the horizon. So the method below can be used by anyone for recession forecasting.

1.) I get a blank circular flow sheet ready for inputting data. 2.) I go to the BEA tables for the NIPA data. (National Income and Product Accounts) I get the following information. Table and line number given. (billions of 2009 dollars) 3.) Then I convert the last line for “Government net borrowing or net lending” from 2013 dollars into 2009 dollars by using a converter which uses the GDP deflator. Here is one. The \$1185 in graph #2, now becomes \$1116 in 2009 dollars. 4.) Next I input that data into the blank circular sheet. You will notice that the GDP at the end does not equal the real GDP in graph #3. There is always a residual from line 27 of table 1.1.6. So, consumption, Govt. spending, Investment and net exports add up to a different number than the real GDP given in line 1 of that table. 5.) Now using the data we can proceed to determine the consumption rate of capital income. It is a process of deduction getting one number, then another, until we get the number we want. In this step, let’s go ahead and complete the bottom section. There are 3 numbers to obtain.

1. Total Net Taxes = Govt. spending – Govt. borrowing = \$1791
2. Lend(-)/borow = – Govt. borrowing – Exports = -\$3077
3. Gross \$\$ Saving = Investment – Lend(-)/borrow = \$5547 6.) Now I start filling in the top. The first step is to put the real GDP from below into the out-going GDI at the top. Then I input the effective labor share percentage of national income, which in 1st quarter 2013 was 73.9%. The effective capital income share will also be filled in as labor share and capital share add up to 1. The incomes of labor and capital are calculated from their shares. The method of calculating effective labor share is to download the data for the labor share index from this graph at FRED. Then take the index for the quarter in question and multiply it by 0.766. For example, for 1st quarter 2013, the index 96.465 times 0.766 = 73.9%. 7.) The next step is to determine the effective net tax rates for both labor and capital. For capital’s effective tax rate before 2003, I use Jane Gravelle’s data. For data from 2003 to 2011, I use Wikimedia. For data after 2011, I can only estimate. The estimation looks for a balance of movement between the labor’s effective tax rate and the capital’s effective tax rate. In this case for 1st quarter 2013, I set the effective capital tax rate at 15.5%, which gives a capital net tax of \$631 billion. I subtract \$631 b. from \$1791 b. of total net taxes to get labor’s net taxes of \$1160 b. Then I can calculate labor’s net tax rate by dividing labor’s taxes, \$1160 b., by labor’s income, \$11,528 b. The result gives a labor tax rate of 10.1% of labor income. If the capital tax rate had produced a labor tax rate around 5%, I would assume the capital tax rate was too high. and if the capital tax rate had produced a labor tax rate of 20%, I would assume the capital tax rate was too low. Normally the labor tax rate is less than the capital tax rate, so in this case the estimation “seems” balanced. 8.) Now we take the personal savings rate from graph #2, which is 4.1%. I apply this to the labor’s disposable income income of \$10,368 b. which is labor income, \$11,528 b, minus labor’s net taxes, \$1160 b. Thus labor is saving 4.1% of \$10,368 b., which is \$425 b. You can see the personal saving rate in the yellow box. The 3.7% is savings as a percentage of total income, not just disposable income. 9.) Now I determine labor’s consumption by subtracting savings and net taxes from labor income.Labor consumption = Labor income – labor net taxes – labor savings = \$9943 b. 10.) Now that we have labor’s consumption and we know that total consumption is equal to labor’s consumption plus capital’s consumption, we can determine capital’s consumption.

Total consumption = labor’s consumption + capital’s consumption

Capital’s consumption = Total consumption – labor’s consumption = \$10,644 – \$9943 = \$701 billion

Then we can easily determine capital income’s rate of consumption by dividing capital consumption by capital income, \$701/\$4071 = 17.2%. There… we don’t need to do any more with the sheet.  I realize that the information for capital income is still not complete in graph #10, but we don’t even need to complete that information. You don’t have to fiddle with imports, exports or even capital savings. We already know the number we want for recession forecasting, which is 17.2% of capital income is being used for consumption. We can use the same calculation method for any quarterly or annual data. For future data, when you see the consumption rate of capital falling, think recession on the horizon.

For those who want or need total accuracy…

It does not matter if the consumption rate of capital is calibrated accurately or not, it will rise calibrated or not… and it will fall calibrated or not, just the same. It’s the relative rising and falling that is used for recession forecasting. (note: the plot of capital’s consumption could be calibrated by reducing the effective labor share by as little as 2%. source)

One person made a comment on a past post that capital gains taxes change wildly and would affect the calculation. However. if you keep a close balanced eye on labor’s net tax rate, you will spot noise in capital’s tax rate. The key is to hold a steady line with informed adjustments about tax revenues. Then what you end up with is a core rate, similar to core inflation that seeks to clean out the noise. The data used for capital income’s effective tax rates do not show noise from capital gains taxes anyway, so the method above is safe to use for recession forecasting.

Everyone needs to have the advantage to protect themselves well before a recession starts, not just those with their fingers on the pulse of capital. Everyone… Now with the above method, labor has its fingers on capital’s fingers. Everyone, including the stock market has a way to know quarters in advance that capitalists as a group are tightening their belts. There is no way to hide it.