Probability of Recession and Puppies for Everyone

Episode Summary

Executive Summary: Inside Economics featured economist Kevin Hassett discussing supply-chain-driven inflation, a soft Q3 GDP report, and the odds of a Q4 contraction. The second half focused on the Build Back Better tax and spending package, where Hassett supported green subsidies but criticized higher corporate, high-income, book-income, buyback, and wealth-like taxes, arguing they distort incentives and may underdeliver revenue. He also defended the broad effectiveness of the Trump tax cuts and warned deficits matter ultimately because they must be financed by future taxes.

Main Topics: Q3 GDP and the risk of recession (Priority: 5/5): The hosts and Hassett parsed the Q3 GDP print, emphasizing that growth was only 2% annualized and that most of it came from inventory swings, while auto production shortages dragged heavily on output. They debated whether Q4 could turn negative, with Hassett assigning a much higher recession probability than the hosts. Supply chains, inflation, and price distortions (Priority: 5/5): Much of the statistical discussion centered on how supply-chain problems are distorting measured inflation and real output, especially in residential construction, autos, lumber, paint, and other goods tied to shortages and bottlenecks. Labor market tightness and consumer behavior (Priority: 4/5): The group highlighted historically tight hiring conditions and strong consumer travel intentions as evidence that the economy still had underlying strength despite recession chatter and soft sentiment readings. Build Back Better tax design and economic incentives (Priority: 5/5): Hassett reviewed the evolving BBB framework, supporting some climate-related subsidies but criticizing proposed taxes on corporate book income, stock buybacks, high incomes, and unrealized gains as inefficient or precedent-setting policy mistakes. Tax reform philosophy and the Trump tax cuts (Priority: 4/5): Hassett defended the Trump-era tax cuts as having produced real capital spending and wage gains, arguing that critics miss the timing effects and the long-run capital-stock response to lower rates and expensing. Deficits, debt, and future tax burdens (Priority: 4/5): The conversation closed with a discussion of deficits, interest rates, and the long-run cost of government spending. Hassett argued that low rates do not eliminate the burden, because debt must still be serviced through future taxation.

Key Arguments: Q3 GDP was weak because inventory accumulation masked underlying softness, while auto production shortages subtracted materially from growth. The Q4 outlook could be negative if inventories reverse and seasonal patterns weaken, though consumer spending may offset some of the drag. Inflation readings in core PCE and residential construction are being distorted by supply-chain bottlenecks and may not stay as benign as recent monthly prints suggest. High labor demand is still evident: firms report great difficulty hiring, and vacation plans have rebounded, implying consumers are not in panic mode. Some BBB elements, especially green subsidies, have economic logic, but many tax ideas are distortionary and likely to create loopholes, incentive changes, or future policy reversals. A tax on stock buybacks may not be the biggest concern; the more serious issue is the surtax on high incomes, the alternative minimum tax on book income, and the quasi-wealth-tax treatment of unrealized gains. The tax gap is routinely overstated as a funding source; enforcement may raise less than projected, especially if the IRS resources are not enough to close it materially. The Trump tax cuts encouraged capital formation by lowering the user cost of capital and timing investments around the statutory change, leading to higher capital investment and wages over time. Deficits are ultimately financed by future taxes; low current interest costs do not eliminate the long-run deadweight loss of public borrowing. Carbon taxes could be economically efficient if paired with reductions in more distortive taxes, but politics prevent that kind of revenue-neutral tradeoff.

Data Points: Q3 GDP growth: 2% annualized - U.S. GDP in Q3 2021 was described as soft and heavily influenced by inventory swings. Inventory contribution to GDP: +2 percentage points - Inventory accumulation added roughly two points to Q3 GDP. Auto production drag on GDP: -2 percentage points - Motor vehicle production shortages cut about two points from GDP due to chip and supply constraints. Residential construction deflator: 14%, 14%, 15.3%, 12.4% - Kevin Hassett cited consecutive quarterly inflation prints in residential construction costs as a supply-chain story. Conference Board vacation plans: 47.6% - Share of respondents planning a vacation, used as evidence that consumer sentiment remained resilient. Conference Board labor market differential: 45 - Percent saying jobs are easy to get minus percent saying hard to get, near a record high. NFIB difficulty hiring: 62% - Share of firms saying they cannot find workers or are having difficulty hiring. Core capital goods orders: 0.8% - A positive monthly rise cited as evidence businesses are still investing. Core capital goods orders, revised figure: 2.8% - Chris initially referenced a higher monthly rise before clarifying the core capital goods data. Core PCE inflation: 0.2% monthly - Discussed as roughly 2.4% annualized and close to the Fed’s preferred range, though likely temporary. Q4 recession probability (Hassett): 60% - Hassett said a negative Q4 GDP print looked more likely than not. Q4 recession probability (hosts): 10% - Ryan and Chris gave low odds of a negative Q4 print. Top corporate rate proposed in BBB: 48.8% in 2022; 51.4% in 2025 - Hassett objected to the proposed surtax on high incomes and the resulting top marginal rate. Carbon tax example: $25/ton - Used to illustrate how a carbon tax would raise coal prices far more than gasoline or heating oil. Coal price impact of carbon tax: 85% - Hassett cited prior input-output work showing a $25/ton carbon tax would greatly raise coal prices. Gasoline and home heating oil impact of carbon tax: 11% - Illustrative price impact from the same carbon tax example. Debt service: 1 to 1.5% of GDP - Current U.S. debt service burden was described as low, but not a reason to ignore debt accumulation. Marginal cost of a dollar of tax revenue: $1.50 - Used to argue that future taxation to service debt creates deadweight loss. Trump tax cuts corporate score: $300 billion net loss - Hassett said the corporate/international pieces roughly offset, leaving a relatively small net revenue effect in JCT scoring. Original Biden corporate tax proposal: about $1.9 trillion over 10 years - Hassett argued the initial corporate tax increase would have been far larger and less competitive.

Pivotal Quotes: "If you take the carbon tax and then use that revenue to reduce more distortive marginal tax rates... GDP would go up and be good for the economy and be good for the climate." — Kevin Hassett: He explained why carbon taxes can be efficient if paired with lower distortionary taxes. "I think that this is... the thing that's disturbing about it to me is that there are a lot of really cockamamie ideas floating around." — Kevin Hassett: His critique of the Build Back Better tax design, especially book income and wealth-like provisions. "It was all inventories." — Mark Zandi: Summarizing why Q3 GDP looked weak despite a positive headline print.

Implications: Listeners should expect continued volatility from supply chains, inflation, and inventories. Policy-wise, the transcript suggests lawmakers may face tradeoffs between revenue, efficiency, and competitiveness, while the debate over BBB and tax reform will remain highly contentious.