As the chart above shows, real GDP growth has essentially been on a 2% growth path since the middle of 2009. That's about one percentage point below its long-term growth path, and the "gap" between the two is now a bit over $3 trillion. That's a disappointing result, to be sure, but it also implies that the economy has tremendous upside potential, and that is extremely encouraging. As long-time readers will know, I consider that the current recovery has been weak primarily due to rising tax and regulatory burdens and a dearth of business investment (and the two are most likely closely entwined). Rebuilding confidence, reducing the barriers to business investment and risk taking, and increasing the after-tax rewards to investment will thus be critical to closing the GDP gap. The potential rewards to successful growth-oriented policies are hard to overestimate.
Real gross private domestic investment (shown in the graph above) grew at a 3.7% annualized rate from 1966 through 2007, over which time real GDP growth grew at a 3.1% annualized rate. From the peak of the last business cycle in 2007 until March of this year, private investment has managed to post only 1% annualized growth. It's no wonder then that growth in the current expansion has been only 2.1%. Without more investment, there will be a scarcity of jobs, and a scarcity of the tools (machines, computers, software) necessary to boost the productivity of those who are employed. Investment is the key to prosperity, and so far, in the current business cycle expansion, it has been in scarce supply.
A subset of real gross private investment is gross private fixed investment, shown in the chart above. Largely driven by strong residential investment, it jumped at a 12% annualized rate in the first quarter.
As the chart above shows, inflation as measured by the GDP deflator (the broadest possible measure of inflation) was 2% in the 12 months ended March 2017. Forget deflation. The issue now is whether inflation is likely to accelerate from its current 2% pace. It's also significant that despite the sluggish growth of the past 6 ¾ years, inflation has on balance remained well above zero, a result that runs counter to the Phillips Curve theory of inflation, which holds that weak growth and lots of unused capacity tend to depress inflation. Inflation is a monetary phenomenon, not a function of growth.
The key to the future prosperity of the US economy is business investment. Only the private sector can create prosperity; the proper role of the public sector is to uphold the rule of law, ensure personal freedom, protect private property, and maintain the peace—not to create jobs. Prosperity is the result of people working smarter and harder—and taking on risk in the process. In order to get more prosperity we need more investment, and Trump's tax proposals—while far from ideal—go a long way to incentivizing private sector investment.
Lowering the tax rate on big and small businesses to 15% would significantly increase the after-tax rewards to business investment. One simplistic example: currently a business gets to keep 65 cents on every dollar of profit; under Trump's proposal a business would get to keep 85 cents on every dollar of profit. That works out to a 30% increase in the after-tax rewards to running, starting, and expanding a business. (It also suggests that reducing the corporate tax rate to 15% could boost the stock market—which is the present value of future after-tax profits—by 30%.) When rewards increase to such a significant degree it is only reasonable to expect to see a big increase in business investment, which in turn would result in more jobs, more income, and an expanding tax base. Cutting tax rates needn't result in reduced tax revenues, and cutting the corporate tax rate is the most logical place to start if you want to stimulate the economy. And by the way, we need to continue to cut regulatory burdens and simplify the tax code; shrink the government, and give the private sector the room and freedom to grow.
UPDATE: John Steele Gordon yesterday wrote forcefully (and in much greater depth than I do here) about why Trump's tax proposals would be very good for the economy. Trigger warning: he criticizes those who oppose the proposals.