The economy
Yes, some clouds loom on the horizon for the U.S. economy: Soaring housing prices, with a rising risk of a bursting bubble. The prospect of higher interest rates. And ongoing uncertainty about energy prices.
But for the remainder of this year ...
The outlook is for fair weather indeed, with GDP growing at about the same brisk pace it did early this year, about 3.7%. In fact ...
If it weren’t for high energy prices, which will trim growth by a percentage point ...
GDP gains would equal the boomy 1990s.

Corporate earnings remain strong. Among those with hefty second-quarter gains: IBM, Merrill Lynch, Pfizer, AT&T, and Coca-Cola.
And businesses see growth ahead. Purchasing managers expect orders to pick up, and firms of all sizes plan to increase hiring. Layoffs at Hewlett-Packard and Kimberly-Clark, as well as job cuts being considered by Ford, are all a result of company-specific problems, not symptoms of widespread economic weakness.
Capital spending is likely to be solid. Factories are rebounding. Even auto manufacturers, buoyed by summer sales, will inch up production.

Consumers won’t dial back, either. Though flat, housing starts are robust, and new permits are on the rise, signaling more gains ahead. Retail sales will pick up a bit more steam in the late summer and fall.
High gasoline prices haven’t put much of a dent in spending on apparel, household furnishings, and more. Even vacations are unaffected.

Come 2006, look for some of the economy’s vitality to fade.
Long-term interest rates will eventually climb from recent lows.
And housing prices will level off or even reverse in some areas. Homeowners will feel less wealthy, and borrowing against equity is likely to slip.
Consumers will clutch their wallets tighter, holding growth in spending to 3%, down from 3.6%.

Businesses are also likely to be more frugal. High energy costs and slowing productivity gains will curb profit growth and capital investment.
Still, the economy isn’t about to stall.
GDP growth will simply ease back to around 3% for the year ... hardly a stormy climate.

Taxes
Congress will compromise on a repeal of estate taxes. Legislation will be passed in 2005 or 2006 raising the exemption from the tax to between $5 million and $10 million. Lawmakers will cut the top rate on assets beyond the exemption, from 47% today to something close to 25%. The House passed a full repeal, but senators are balking at the cost, arguing the revenue is needed to prevent the deficit from skyrocketing.
The agreement will keep a break on inherited assets. Right now, the tax basis is the date-of-death value, so heirs don’t pay tax on prior appreciation. Under the House bill, heirs of large estates would be required to use the decedent’s basis to calculate capital gains. But the Senate won’t agree, and the tax break will be left in place.

Most states will go their own way on estate taxes. They worry that they’ll lose critical revenue because their systems are linked to the federal estate tax law. So far, 18 states have passed legislation disconnecting their estate tax or establishing a whole new separate tax.

The energy bill working its way to Bush will have big tax breaks.
For businesses: Expensing of energy-saving upgrades and a credit for efficient furnaces or water heaters placed in commercial buildings.
And a $2,000 credit for building new, energy-efficient homes.
The breaks take effect in 2006, so delaying action makes sense.
For consumers: A credit for energy-efficient home improvements ... 20% of the cost of doors, windows, skylights, etc., for a primary home.
A solar energy tax credit. 15%-30% of the cost of the systems to heat a residence or its water system, but not pools or hot tubs.
A credit for hybrid vehicles. The current $2,000 tax deduction will be changed to a credit of up to $2,400, depending on fuel economy.

Business Outlook
Retail sales will likely climb a solid 5.5% this year, up from 5% in 2004. Among the big winners will be discounters Wal-Mart, Target, and others, which keep taking sales away from department stores. Also doing well: Abercrombie & Fitch, Bebe, and other specialty stores.
Signs point to strong back-to-school and year-end holiday sales, paced by the heaviest demand in years for computers and related gear.

Now retailers can do more than just moan about bad weather.
Private forecasters are getting much better at looking ahead six months or more to predict storms and unusual weather patterns.
They can take the guesswork out of stocking a store’s inventory, allowing retailers to order more winter clothes or more air conditioners as the forecast warrants. Fees begin at a few thousand dollars a year.
Another option: Insurance for a rainy day. WKF&C/Good Weather, All Weather Insurance Agency, and other firms sell policies that pay off if big storms or frigid conditions ruin a blockbuster sales event.

Steel prices won’t go any lower. The recent slide from $600 a ton to $500 was mostly a temporary supply/demand hiccup. Industrial demand by automakers, appliance companies, and others is picking up steam. Prices will hang in the $500-$525 range this year, then edge up next spring.
A no-fault asbestos trust fund will get the nod from Congress, maybe this year, more likely next. After four years of stop-and-go talks, labor groups, the asbestos industry, and insurers are ready to sign off. The $140-billion fund to settle injury claims affecting 8,000 companies will be financed for 30 years by lawsuit defendants and their insurers.

© 2005 The Kiplinger Washington Editors, Inc.