Corporate Tax Receipts Plunge 31% in Q1-- Warning of EPS Declines?

As corporate earnings season fires up, a piece of data from the U.S. Treasury could be a warning shot for stock market investors. Federal corporate income tax receipts plunged 31% in the first quarter of 2011 from a year earlier, a potential indicator of weaker-than-expected Q1 corporate profits.

The 31% drop in corporate tax receipts is a big reversal from the second half of 2010, when corporate income taxes grew by 23%.

"Perhaps it’s mostly because of tax law changes," Moody's Economic Group's Team Managing Director John Lonski wrote in a note to clients, "but the...drop by the US government’s gross corporate income tax receipts might raise a few eyebrows if only because of the relatively strong correlation between the year-over-year percent changes of federal corporate income tax receipts and profits from current production."

Profits from current production are pre-tax operating profits minus extraordinary gains and losses.

Since 1985, corporate tax receipts have mostly moved in lockstep with profits from current production, Lonski notes.

The exceptions have been years when corporate taxes were cut to stimulate the economy, as occurred in 2001-2002. In the two quarters ended March 2003, federal corporate income taxes fell by 24% year over year, but profits rose 15.4%.

One period where the correlation is evident was in the last quarter of 2008, when the S&P slid 22% after Lehman's collapse. Then, corporate tax receipts fell 38%.

Blue Chip Economic Indicator's latest estimate projects Q1 profits from current production will grow by 7.5% in 2011. That's a big drop from Blue Chip's estimate for 29.2% growth in 2010. So even if the plunge in corporate tax receipts resulted from a change in the tax law rather than a drop in corporate earnings, Blue Chip's estimates -- the mean growth projections of 53 top research firms and blue chip companies -- indicate a serious slowing in earnings growth from last year.

"Blue Chip's estimates have been a pretty good guide for pace of corporate earnings ," Lonski noted.

Income tax receipts are a difficult indicator to use because of loopholes and corporate structures designed to reduce taxable income, according to Kanundrum Capital President and Fast Money trader Brian Kelly.

"However, when viewed in conjunction with other indicators, it does begin to paint a picture of weaker earnings. GDP forecasts for Q1 have come down dramatically, it is hard to believe that corporate earnings will remain elevated in a below-trend growth environment," Kelly added.

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