L-Shaped Recovery and the Trampoline Effect

Some years ago, I talked about government interference affecting the economy. There’s a pair of posts: Parabolas and The Trampoline Effect. When there are downturns in the economy, there’s usually a natural rebound, forming a parabola, like a U. The bounce back usually reaches and exceeds the start of the fall pretty quickly. But if government steps in to “help,” or interfere, then you get something more like “help” on a trampoline, when someone steps in purportedly make the bounce higher. That help disturbs the natural up and down, and takes the energy out of the bottom of the bounce, so you don’t go back up. You just sort of stumble, and the trampoline flattens. And then you have to get going again from scratch.

In economist terms, this is an L-shaped recession recovery, instead of the usual U-shaped recovery.

Here’s the definition: 

L shaped recession—refers to a period of stagnant recovery after initial fall in GDP. Even though technically the economy may have positive growth (e.g. 0.5%) it still feels like a recession because growth is very slow and unemployment high.

You know the phrase, about the scariest words: “I’m from the government, and I’m here to help.” Government’s role isn’t to interfere, or intervene. It’s to set up the background for free enterprise to take place. 

Government isn't the only interference that can cause an L-shaped recession, but it's the usual suspect. When we look at the past decade, we see an L-shaped recession/recovery, and it wasn't just bad luck; it was government caused. 

There are a number of measures of how well the economy is doing. Growth in GDP is one. In fact, a recession has a specific definition related to GDP: "a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters."

The converse is that two successive quarters of growth, however minimal, signify the end of the recession. But in an L-shaped recession, getting to technical recovery likely takes longer, probably over a year, rather than merely months. But getting back to starting position can take much longer, multiple years.

The L-shaped recession recovery looks like this:

Such a "recovery" can take so long that various opinions may start calling it a square root-shaped recovery, meaning that, instead of ever getting back up, we should expect a new, permanent, lower growth reality. Obama and George Soros agreed on this "just the new reality" description of the 2008-2009 Great Recession. The malaise economy of Jimmy Carter was also described as a new normal that turned out not to be normal, after a bit of a Reagan tax cut.

And the Great Recession wasn’t a square root-shaped “recovery,” we now know, because the malaise of extremely low growth wasn’t permanent. It went away as soon as we had a government regime change that made necessary changes. They haven’t been extraordinary changes: lower taxes across the board, and concerted attempts to get rid of burdensome regulations.

We didn’t have to get all the way to the ideal lowest possible tax rate, just better. And we didn’t have to get rid of all burdensome regulation, just go in that direction, and stop the threat of ever more regulations that could be placed at any time, causing businesses to be wary about investing and growing. When people are free to make use of their own money, and can plan without government-induced uncertainty, that's the energy we need to get the economy moving back upward.

We can see some examples of the L-shape in various charts. A typical chart for showing recessions is GDP growth. This one, from the Center on Budget and Policy Priorities (CBPP)[i]

Because growth, by definition, rises, in order to see the parabolas and other shapes of recessions and recoveries, you need to turn the chart somewhat sideways, so the rise line is horizontal. The green is to show the L-shape.

Besides GDP growth, there are some other measures. One is unemployment. Here’s a comparison of recent recessions and up to five years out.  In this chart the U-shape, or parabola, is upside down, because we want unemployment to be low. It goes up during the recession and down afterward. You can see that the unemployment spike was a bit higher in 1982, but by one year out had reached its starting point, and then continued dropping. The 2009 recession went higher half a year out, had some downs and ups for a year and a half, and afterward only slowly began dropping back down, taking seven years or more to reach pre-recession rates.

It’s possible for unemployment to go down even though there are more people not employed. Unemployment is measured by taking some combination of people applying for unemployment benefits and polling. That misses people who would be looking for work in a less hopeless economy. People who can’t find work could try to get more education, or could be just staying home. They don’t get counted. So another way to look at economic vitality is the employment-to-population ratio.

This one gives us a really clear picture of the L-shaped recession/recovery. I’ve highlighted the Great Recession in green, and in yellow are a few other more typical recessions with a quick rebound. On this chart, it looks like there might be another L-shaped recession just after 1960.

Another chart that shows the L-shape is average private sector hourly earnings. The housing and banking bubbles burst in the last quarter of 2008, which precipitated the drop. They didn’t start to rise again until 2015, and we’re still quite a distance from the starting point. The source for this chart seemed certain, later in the article, that things would have been much worse without the government interference. It’s hard to show an alternative version to use for comparison, but it is my assertion that government interference caused the intensity of the problem as well as the continuation.

The 1929 market crash was similar. It was beginning to right itself within months, but then government stepped in with one intervention after another, intensifying and continuing the pain for more than a decade. It wasn’t the war that ended the depression, because there was so much to produce for the war; it was that FDR focused on the war instead of the economy, and he largely quit experimenting with ever more interventions.

There was some good news from The Heritage Foundation's 2018 Index of Economic Freedom. We used to be ranked “mostly free,” but had been less free since the beginning of the Obama administration—or maybe since the legislative takeover by Democrats two years before that. Now we’re moving back toward freedom.

The United States, ranked “mostly free,” had not been performing well in the index over the last decade. That precipitous slide has now fortunately come to a halt, with signs of renewed economic growth reinforced by major regulatory and tax reforms that elevate business confidence and investment. It is notable that the U.S. economy grew at a rate of about 3 percent in the last three quarters, something that economists said was very unlikely just a year ago. For the first time in a while, the United States isn’t just economically stronger. It has a real chance to become economically freer in the coming years.

We’ve had two additional quarters of higher growth since that assessment last February. So the news is even better.

When somebody interferes with your jump back up on a trampoline, it takes some regathering your balance and re-energizing your jump. And that gets harder when the “friend” keeps their hand on the trampoline. But once they get out of the way, the energy you put into the jump gets you rising again.

It’s good that happens in the economy too. When we move closer to a free market, not only do we become more prosperous, we become more free.

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[i] CBPP is the source for the remaining graphs in this piece, although some have my marks on them.

The Tax Day Flood

It’s tax filing deadline day—an extension from the usual April 15^th. We’re having a flood here in Houston, from storms all night long. Several hours during the night we got 2-3 inches of rain per hour. In our neighborhood we got 15.6 inches overnight, double what we got during Tropical Storm Allison. The nearby bayou went over its banks; it’s a 500-year flood level. Our neighborhood, relatively new, is built up several feet about street level, so we’re safe. But a number of neighbors and people we know from church have some flooding. And the main street we have to take to get out of the neighborhood has flooded.

Houston's Tax Day Flood
photo from Houston Chronicle reader, here

This afternoon we’re having a bit of a reprieve between storms that are predicted throughout the week. That should give the water a chance to flow into the reservoirs down the road. We’re the bayou city for a reason; bayous (i.e., drainage ditches) are in and around every neighborhood. Because heavy rains happen here. So we’ve planned for them. And, when whatever we do is not enough and flooding happens, we dig in and help each other out.

There ought to be some metaphor in here about taxes. One might be that we’ve been suffering something of an economic catastrophe since around late 2008—that’s eight years. At last there are signs of the bad stuff letting up in the not-too-distant future.

I’m looking at the possibility that we could get lower taxes, simpler taxes, higher growth—all the things that happen when the government gets out of the way. These things might just happen, if we get the Ted Cruz tax plan.

It’s a simple plan. He put out an ad this past week, explaining it in one minute:

You can read the summary on his website. 

On Friday Ted Cruz appeared on CNBC’s Squawkbox, where he talked about his tax plan with Joe Scarborough and team. It was a good opportunity to hear what the outcome for the economy will be of this simple plan. So I’m sharing a few portions of it.

Joe Scarborough starts the conversation asking about economic growth.

Ted Cruz: Growth is foundational. My number one priority is growth. Every other problem we’ve got, whether it’s unemployment, the debt, the deficit. Whether it is strengthening and preserving social security and Medicare, or whether it is rebuilding our military and keeping us safe—you’ve got to have growth to make it work. And we have been trapped in stagnation for the seven years. And if we don’t turn that around, nothing else gets fixed….

Historically, since WWII, our country has grown an average of 3% per year. And yet from 2008 to today it’s averaged only 1.2% a year. If we stay at… this level of growth, these problems are not solvable….

My economic agenda is focused very directly on growth, because if you get back to historic levels, 3, 4, 5% growth, suddenly the federal government numbers turn around dramatically….

Joe S is concerned about what looks like a global problem and asks about that. Ted Cruz responds with examples from history, from Coolidge, to JFK, to Reagan, where the right policies turned things around.

TC: Taxation reform and regulatory reform are the two most potent levers that the government has. In the 1960s, John F. Kennedy did the same thing. In the 1980s Ronald Reagan did the same thing. We have three periods in the past century, the 20s, the 60s, and the 80s, and in every one when we passed tax reform and regulatory reform, when we reduce the burdens of government on small businesses—and small businesses are critical; they’re the job creators; they’re the innovators; they’re the catalysts—the result has been record-shattering growth. We just need to do what works.

At 13 minutes in, Ted Cruz gets to describe the actual tax plan.

TC: My tax plan is simple. It is a simple flat tax. For a typical family of four, for the first $36,000 you earn, you pay nothing. Zero income tax. Zero payroll tax. Nothing. Above $36,000, each marginal dollar you pay a simple flat tax of 10%.… Everyone pays the exact same….

Another difference, by the way, no longer do you have any differential rates between ordinary income and dividends or cap gains…. Everything’s 10%, which means people actually allocate capital based on where it’s efficient, rather than on what the tax laws say, because the tax laws are neutral to everything.

And then, on the business side, we abolish the corporate income tax. As you know we have the most punitive corporate income tax of any developed country in the world. We abolish the Obamacare taxes. We abolish the payroll taxes, which are the single biggest tax most working Americans pay. And we abolish the death tax, which is a tremendously unfair and punitive tax on farmers, on ranchers, on small businesses. And we replace all of those with a simple 16% business flat tax.

And the effect is an incredible catalyst for job creation and wages going up, and bringing jobs back to America. That’s my priority: high-priced jobs coming back to America, wages going up for everyone.

When government people score a plan, they give a number on what it will cost. But they assume the tax cut will do nothing but reduce government revenue. That is called static scoring. Ted Cruz gets to talk about that, and offers a more likely dynamic scoring scenario.        

                                                                                                                             

TC: I suspected you might say that, so I actually printed out a comparison of tax plans that was done by the Tax Foundation. The Tax Foundation is a nonprofit…. It is nonpartisan, and it scores everybody’s plan. If you look at it the way they score it, in terms of the cost—Now, the static cost is $3.6 trillion; that’s a lot of money. But scoring it static is assuming that cutting taxes has no impact on the economy—that doesn’t make any sense. I mean, that is an Alice-in-Wonderland scoring.

If you score it with dynamic scoring, which is, you take into effect what is going to happen when you cut taxes, then the total cost of this plan is $768 billion. It’s less than a trillion. If you contrast that, for example, to Donald Trump’s plan, Donald’s plan costs over $10 trillion. So mine is less than a trillion…. And the difference is, even though Donald’s is more than ten times as expensive as mine is, my tax plan produces more economic growth. 4.9 million new jobs, coming from this capital investment, increases 44%.

One of the big reasons is that any business, when you invest in capital, it’s immediately deductible. No longer do you have complicated depreciation tables. None of that matters. If you make a capital expenditure, you immediately expense it. That is a powerful catalyst for growth.

And then, the most exciting thing about it is just the impact on after-tax wages, take-home pay. Every income group, from the very poorest to the very richest sees a double-digit in after-tax pay. The average family in America under the Cruz simple flat tax will take home $7600 dollars more. Seven thousand six hundred dollars. That’s real money that makes a difference for someone struggling to make ends meet

Around 34 minutes into the conversation, Joe Scarborough brings in economist Art Laffer. Laffer, best known for the Laffer Curve, advised Reagan back in the day, and has helped Cruz in developing his plan. He is asked whether he can verify this “dynamic scoring.”

Art Laffer: Of course dynamic scoring’s the right way to do it, Joe…. I did watch the other segment. I thought Ted did a great job of explaining exactly how it works and what the dynamics of it would be—except that I think he underestimated the dynamics that will occur.

If you look at his tax plan, it makes Reagan’s tax plan look weak, in the 1980s. I would expect to see a greater growth rate, not only because Obama is worse than Jimmy Carter, but because this tax plan is even better than Reagan’s. It’s would take the top rate down to 16% on businesses and 10% on individuals. And I think you’ll get growth rates higher than Reagan’s, which were enormous, Joe. You’ve got 6, 7, 8% real growth annualized on a quarterly basis in the years ‘83, ‘84. And in a number of the quarters you’ll get more than that. Our economy is relatively much worse off than it was even under Jimmy Carter.

There’s some discussion about the excuses, relating to the Fed, about why this recession is supposedly different from all others, and then Ted Cruz is brought back in.

TC: I agree with Art that the numbers that were estimated, if anything they’re underselling the GDP impact. My object is a minimum of 5% GDP growth. And I would note JFK, when he campaigned, he campaigned promising 5% GDP growth, and he ended up producing 5% GDP growth. 

AL: And the tax revenues were much higher too. He went into surplus because of economic growth.

TC: That is exactly right. And the wealthy ended up paying more. When you cut the tax rates, the wealthy paid a higher percentage of taxes.

Art, tell us, what would the impact be on the economy? What would the impact be on working men and women, if we had four years or eight years of 5% GDP growth, instead of the stagnant 1 and 2% we’ve got right now?

AL: Well, the impact would be huge. I mean, the biggest driver of tax revenues, Ted, is GDP growth.

But what very few people have talked about on your plan, and, if I may, is the revenue impact on cities, counties, local districts, and state budgets would be enormous as well. And no one’s even looking at that.

The impact on income redistribution would be also huge. I mean, John F. Kennedy put it so beautifully—you referred to Kennedy, and he was my hero—John F. Kennedy said the best form of welfare is still a good high paying job. And creating those jobs will reduce inequality dramatically. And that will lead to more prosperity everywhere.

So you’re going to have much higher revenue impact. I think you’re going to get even higher growth rates than 5%. And you’re going to reduce inequality. What’s not to love in this plan?

Indeed. What’s not to love?

But would those good outcomes really happen? I think they would. I remember the Reagan years, which is helpful. But I think hearing from business people is helpful. I came across a five-minute video by businessman/speaker Ryan Moran, in which he talks about the so-called “fair share” he has to pay. He holds up a check for $170,000 he’s paying in taxes. This is not his tax bill; he paid the estimated tax in December. This is just the overage, by which he was off. He explains a bit about what he’s paying. And then he talks about what he could do with that money.

Now what could a businessperson do with $170,000? You know what I would like to do? Hire more people. I’d love to hire three highly paid people at $55,000, or five people at $35,000. But I can’t. ‘Cause it’s going to the government…. I’d love to put it back into a business, or back into people….

So the government can’t just create things out of thin air. It has to take—it has to take— from what would be productive: hiring people, investing into more products and services, creating better experiences for customers, putting into a college fund for my ten-month-old daughter. Any of that would be a better use.

But, no. People got to pay their “fair share.”

It’s not just speculation. People really do make better use of their money than government does.

I like that a 10% flat tax is pretty similar to what God does, with tithing. Let’s limit what government takes from us, and limit what government does with the tax money it gets—to the powers enumerated in the Constitution. 

Let the government-caused catastrophes end. And then watch us thrive.