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The “Magic Formula” Is The Secret To Another Century Of American Prosperity

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Published : April 01st, 2019
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Economics is easy. You just have to get two things right: Low Taxes, and Stable Money. Get this right, and everything else tends to follow with relative ease. Get it wrong, and the endless problems and difficulties that ensue will prove insoluble.

I like to call it “the Magic Formula.” If it seems obvious, that’s because it is. Capitalist economies don’t really work very well when taxes are high or money is unstable. Nevertheless, the Magic Formula is often ignored. Taxes today are not very low; money is not very stable; both might get worse, not better. This has consequences.

I explore this idea in my new book, The Magic Formula, which is now available in print and eBook versions. I don’t think people have much idea just how good things can get, with the Magic Formula. It is not a matter of an extra five or ten percent of economic growth. Over the course of only a few years, it can be hundreds of percent. High growth emerging market economies commonly expand at a rate of about 12-16% per annum (nominal growth with a stable currency). But, even an increase of growth by one percent per year — an amount so small that it is barely noticeable — can change a country’s destiny.  In 2018, the U.S. Federal government’s debt held by the public was 78% of GDP. Using the Congressional Budget Office’s assumption of 1.9% real growth, the debt is forecast to rise to 127% of GDP in 2040. But with 3.0% real growth (the growth rate experienced in 2018 in part due to the recent reduction in corporate taxes), debt/GDP in 2040 has been estimated at 58%.

The Magic Formula (2019), by Nathan Lewis

When you get on the wrong side of the Magic Formula, all these things work in reverse. I call it the “Spiral of Decline.” Higher taxes lead to a sluggish economy; tax revenues disappoint; unemployment rises; demands for every kind of socialistic welfare program increase, and justifiably so given the genuine difficulty; corporations turn to government subsidy and corruption to stay afloat; spending rises; budget deficits increase. The next step is commonly a combination of higher taxes, and some kind of “easy money”; and the Spiral of Decline takes another turn for the worse. You can see this process happening all around the world today, among some European governments, or in high-tax States like New York, Illinois and California. In the book, I describe how a similar process led to the disintegration of the Muslim Caliphates in the eleventh century, the Spanish Empire in the seventeenth century, and the British Empire in the twentieth.

One of the things that history shows is that things can get really bad — Venezuela-like bad — but a country can recover, in surprisingly short time, once it embraces the Magic Formula. Actually, a country might not only “recover” to some prior level of prosperity, but begin an advance to unprecedented new heights. China actually adopted communist central planning, with results so bad that famine became common. Its economic advance in recent decades, fueled by the Magic Formula, has been a wonder to behold. Greece, one of Europe’s laggards today, could become one of the wealthiest countries in Europe, if it adopted the Magic Formula. It wouldn’t take long, either; probably, one generation would do it. As I describe in the book, Ireland was for two centuries one of Europe’s poorest countries; after the government turned toward the Magic Formula in 1985, it took only twenty years to surpass Germany to become one of Europe’s wealthiest. (Unfortunately, the financial crisis in 2008 knocked Ireland off the growth path.)

Today, in the U.S., we are actually talking about 70% income tax rates and “modern monetary theory.” As debt, deficit and entitlement issues intensify in coming years, the U.S. government may turn to higher taxes and, when the economy drags as a result, “easy money” in response. We could have another century of prosperity in the United States, but it will require the Magic Formula — either as a means to avoid a crisis, or a means to recover afterwards.

But the Democrat socialists are not the only danger. Unfortunately, throughout U.S. history, Republicans have often been as bad as Democrats about this. During the 1950s, top U.S. income tax rates were as high as 91%; the country had four recessions in twelve years, 1949-1960. President Dwight Eisenhower consistently blocked Congressional Republicans’ attempts to lower tax rates, citing budget deficits. In desperation, and with an election coming up, the Eisenhower administration took to leaning on the Federal Reserve for assistance; it caused a minor monetary crisis in 1960. It took Democratic President John F. Kennedy to begin the process of amending these self-destructive policies. Taxes in Britain, in the 1950s and 1960s, were far worse; the result was that, in 1970, per-capita GDP in Britain was less than half that of the U.S. In thirteen years of Conservative rule during those decades, nothing was done. Instead, the British pound was devalued twice. Britain had to wait until Margaret Thatcher’s embrace of the Magic Formula in the early 1980s stopped the long decline. Today, a broad swath of conservatives remain convinced that keeping U.S. corporate tax rates among the highest in the OECD would have been the only fiscally responsible course. They are as wrong as their predecessors.

I think we are entering an era when big changes will take place. The “post-WWII arrangement” that has long defined the limits of policy will pass; and something new will take its place. This “something new” is likely to be much more socialist, as every Democrat loudly declares today; or, it will become much more capitalist, closer to the America of old, when income taxes were unconstitutional and money was based on gold; and when the Magic Formula not only propelled the United States to the first rank of countries, but inspired the rest of the world to imitation.

(This item originally appeared at Forbes.com on April 1, 2019.)

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Nathan Lewis was formerly the chief international economist of a firm that provided investment research for institutions. He now works for an asset management company based in New York. Lewis has written for the Financial Times, Asian Wall Street Journal, Japan Times, Pravda, and other publications. He has appeared on financial television in the United States, Japan, and the Middle East.
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