Growth Is All That Matters, and Cruz's Tax Plan Would Generate the Most

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The four candidates still in the running for the 2016 presidential election have all offered tax reform proposals. These plans have been widely analyzed. The analyses have identified who would pay more, who would pay less, and the projected impact upon the federal tax take (the percent of GDP that the federal tax system brings in). Unfortunately, the analysts have glossed over the only thing that truly matters about any tax plan: its impact upon economic growth.

Growth matters because the future matters, and because both human psychology and the financial markets base their assessments of the present (e.g., are things good or bad; asset market values) largely upon expectations regarding the future.

Quantitatively, the future is taken into account by performing present value calculations. The financial markets, which finance federal deficits and determine the value of the assets in pension plans, run on present value. And, present value calculations show that the growth rate of real GDP (RGDP) is the only thing that matters at all.

Here is an illustration. Over the entire economic history of the U.S. (1790 - 2015), RGDP growth has averaged 3.66%. If Bernie Sanders, rather than George Washington, had been our first president, and if his socialist economic policies had cost us just 0.1 percentage point of growth (which is the smallest increment that the Bureau of Economic Analysis can measure), 2015 GDP would have been $3.44 trillion (19.2%) lower.

"The one percent" currently earns 21.2% of national income, with the remaining 78.8% going to "the ninety-nine percent." Even if Bernie Sanders (the 2016 edition) could somehow equalize all incomes without destroying the economy (which he cannot), the "ninety-nine percent" would be better off today receiving 78.8% of a 3.66% RGDP growth economy, than they would be if they were getting 99.0% of an economy that had grown at 3.56% for the past 225 years.

But wait-the comparison gets even starker when you do formal present value calculations.

The most recent "Long-Term Budget Outlook" (LTBO) published by the Congressional Budget Office (CBO) predicts that the U.S. economy will grow at 2.25% real, and that the federal government will be able to fund its deficits at a 2.00% real interest rate.

For each RGDP growth rate, there is a federal tax take that will yield the same present value of future federal revenues (PVFRs) as the CBO's LTBO case. The combinations of RGDP growth rates and tax takes that have the LTBO PVFR create "The Woodhill Curve."

Below is the Woodhill Curve generated by the latest CBO LTBO assumptions*.

Here is what the Woodhill Curve means regarding the presidential candidates tax plans:

1. Democrat Bernie Sanders is promising to raise the federal tax take by 6.40 percentage points, from the CBO's projected 18.1% of GDP to 24.50% of GDP. However, a loss of only 0.045 percentage points of economic growth (i.e., a reduction in the RGDP growth rate from 2.250% to 2.205%) would completely negate Sander's enormous tax increase. In other words, losing less than half of the smallest growth increment that the BEA reports would leave the federal government with no more long-term spending power than it has now.

2. Democrat Hillary Clinton is proposing to collect an additional 0.50% of GDP by raising taxes on "the rich." If this were to reduce RGDP growth by only 0.004 percentage points, the federal government would be no better off financially (and the nation would be worse off).

3. Republican Donald Trump is offering a tax plan that would cut the tax take by 4.00 percentage points. On a present value basis, it would take only an additional 0.037 percentage points of RGDP growth (i.e., an increase from 2.250% to 2.287%) to "pay for" Trump's tax cut.

4. Republican Ted Cruz is proposing a tax reform plan that would reduce the tax take by 3.60 percentage points. The RGDP growth increment that his plan requires is 0.033 percentage points (i.e., an increase from 2.250% to 2.283% growth).

The above numbers are derived from straightforward calculations based upon the CBO LTBO assumptions. The reason that the relationships are so extreme is that the CBO is projecting an average RGDP growth rate (2.25%) that is above the real interest rate (2.00%). However, this is not an unreasonable assumption. Over all of U.S. economic history, our average RGDP growth rate (3.66%) has certainly been higher than the real interest rate on federal debt.

Given that economic growth is the only thing that really matters, both to our standard of living and to the solvency of the federal government, we should be looking at cutting taxes to increase growth, as the Republican candidates are proposing. In the face of the numbers, you would have to be either crazy or a Keynesian** to be advocating tax increases, as the Democratic candidates are doing.

So, what kind of boost to RGDP growth could we reasonably expect from cutting taxes?*** Let's look at Ted Cruz's plan, which is more "pro-growth" than Donald Trump's.

By eliminating the corporate income tax, the capital gains tax, and the death/gift tax, it appears that Senator Cruz's plan would cut taxes on savings and investment by 2.6 percentage points of GDP. If all that this did was to cause nonresidential capital investment to go up by 2.6 percentage points of GDP (and it is likely that the increase would be much larger, due to incentive effects), this would increase RGDP growth by 1.14 percentage points (i.e., from 2.25% to 3.39%)****.

With 3.39% RGDP growth, America could be America again. Social Security and Medicare would be solvent, without tax increases or benefit cuts. Yes, the budget deficit would increase during the first few years, but then it would come down faster than the average CBO analyst can imagine.

The numbers are clear and compelling. America must cut taxes to increase capital investment and economic growth. Right now, Ted Cruz has the best plan to do this of any of the presidential candidates.

*The present value calculations are done using the Social Security Trustees' "to the infinite horizon" methodology, which is also how the financial markets judge federal government finances.
**Keynesians have a "Balanced Budget Hypothesis" (BBH), which purports to prove that raising taxes and spending in tandem would actually boost RGDP growth. Their BBH can't explain why the optimum tax take wouldn't be 100%, though.
***Assuming that the new president reins in the Federal Reserve, and requires that they stabilize the dollar. Without a stable dollar, no tax plan will work well.
****The U.S. economy delivers a consistent 44% GDP return on nonresidential assets.


Louis Woodhill (, an engineer and software entrepreneur, and a RealClearMarkets contributor.  


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