An Additional 1% Of GDP Growth Per Year Changes The Game Completely

(This item originally appeared at on May 10, 2018.)


It’s funny how, after all this time, the idea that lower tax rates can allow more growth, and improved overall economic health, is still held by only a small group of politicians. It’s really just the flip side of the idea that high taxes can impede growth, which you would think would be as obvious as gravity. There is no investment or economic process that is improved by the government confiscating money from the participants. You can certainly argue that the money is spent in a way that produces a benefit that outweighs the harm of taxes; but this simply confirms that taxes are harmful. Yet, the idea is rejected by all manner of elitist organizations, and also nearly the entirety of academic economists. A lot depends on that small group of politicians not losing their nerve.

An increase in growth by 1% per year is not really very much. We aren’t talking about Japan-in-the-1960s levels of growth here. They cut taxes every year from 1950 to 1974. Between 1950 and 1970, tax revenues increased by sixteen times. We aren’t talking about Germany-in-the-1950s levels of growth. They cut taxes in 1949, 1950, 1951, 1953, 1954, 1955 and 1958. The economy grew 361% between 1949 and 1963; tax revenues increased by 450%. We aren’t talking about Ireland in the 1986-2006 period, when growth went from sub-2% to 8%, tax revenue/GDP fell from 38.1% to 29.4%, the corporate tax rate fell from 50% to 12.5%, inflation-adjusted tax revenues doubled, deficits in excess of 10% of GDP turned to surplus, and government debt/GDP fell from 116% to 22%. We are not talking about adding 5% or more to economic growth rates, which other countries have done. We’re just talking about 1% per year – from about 1.8% to 2.8%.

But this 1%-per-year adds up. Let’s say that a reduction in tax rates is expected to lead to a reduction in revenue by 5% — for example, from 20% of GDP to 19%. In five years, GDP would be about 5% higher than it would have been otherwise. Instead of 20% of 100, you would get 19% of 105, which is about the same amount of revenue. Plus, you would probably have fewer expenditures, because a healthy economy has fewer needy people or struggling companies. In ten years, GDP would be about 10% higher. A ten-year budget forecast would show that the tax cut would produce no decrease in revenue, over that ten-year period.

The Congressional Budget Office’s latest projections of revenue and spending, reflecting the influence of the 2017 tax reform, supposedly reflect “dynamic” estimates including the growth effects of a fourteen-point reduction in the corporate tax rate, among other positive elements. For the 2018-2028 period (ten years), real GDP is estimated to be 0.7% higher.

Now, that is not 0.7% higher per year – an increase in the growth rate. No, it is 0.7% higher overall, over ten years. This is so close to “no change at all” that it is effectively the same. The CBO’s “dynamic” estimates are no different than their “static” ones.

One interesting thing, however, is that even without any meaningful growth, the CBO estimates that “economic changes” in revenue, for 2018-2027, will largely offset the supposed revenue declines from “legislative” changes. A total “legislative” (this seems to mean “static”) revenue loss of $1,690 billion over ten years is offset by $1,088 billion of “economic” revenue gains, to produce a net revenue loss of $602 billion. While this is not quite the same as “tax cuts paying for themselves,” it is actually about 64% of the way there, which is something. (I’ve contacted the CBO for more detail on what these “economic” changes consist of.)

The CBO expects big deficits in the future, but this is due to increasing spending mostly from mandatory programs. For 2019, the net effects of changes in taxes is expected to produce $197 billion less revenue than would have otherwise been the case. This is a decline of about 5%, from 17.3% to 16.6% of GDP. A 1% increase in growth would make that revenue loss disappear in about five years; in ten years, we would be getting about 5% more revenue, with lower taxes. The CBO expects GDP growth in the range of 1.5% to 1.8% for 2021-2028. That is not a very high hurdle. If GDP is about 1%-per-year higher, or about 10% higher after ten years, that would mean an additional $495 billion in tax revenue in 2028 alone.

In fact, the CBO’s growth estimates have been off in the past by about 1% per year. Between 1983 and 1999, the CBO issued two-year forecasts that added up to a 2.7% growth rate. The actual rate was 3.7%.

Remember, the CBO’s total ten-year “cost” (estimated revenue reduction) of the 2017 tax reform, after adjusting for “economic” factors, was $602 billion. Give up $602 billion, spread over ten years, to get $495+ billion per year in additional revenue due to growth benefits? I wish I could set up a hedge fund to get those kind of returns.

It would be so much fun, once you figured out what was going on, that you might want to do it over and over again. Now can you see why Japan, Germany and Ireland started to cut taxes nearly every year?

The real budget problem is spending: due to expanding “mandatory” spending due primarily to retiring Boomers, Federal spending/GDP is expected to expand from 20.6% of GDP in 2017 to 23.6% in 2028, resulting in deficits in the 5%-of-GDP range. These deficits could be quickly solved by capping spending to the rate of inflation only. If we assume that all current tax cuts are made permanent, the deficit would gradually shrink and turn to surplus in 2028. If we assume growth of 2.8%, we would turn to surplus in 2025.

After big improvements in the corporate tax climate, the next step for growth-friendly Republicans is some serious reform of individual income taxes, including much lower rates. This would probably be matched with major simplification and reduction of exemptions and other “tax expenditures.” Major spending reductions aren’t necessary – you just need to hold the line on spending increases to the rate of inflation. Admittedly, this will now require substantial changes to “mandatory” spending, which is no small task.

The advantages of even moderate improvements in growth are so great that they make all other problems much more manageable. Let’s get going on the Great Tax Reform of 2019.