South Carolina Primary Predictions and Thoughts

Well, the first in the South primary, South Carolina, is upon us, and public polling has added a bit of uncertainty to the race. While most polls had been showing Donald Trump with a commanding 15+% lead, others since the debate show a less than 5% lead (perhaps his George W. Bush attack did have ramifications). Senators Marco Rubio and Ted Cruz appear to be battling for 2nd and 3rd, though some polls have also shown Governors Jeb Bush and John Kasich with a potential shot at 3rd while Dr. Ben Carson has been languishing. Below are my predictions as well as what each candidate needs to achieve to consider the night a success.

 

Donald Trump: Trump is the national frontrunner and every candidate would trade places with him. Given all the polls showing him up 10+%, a loss in SC would be a major surprise and setback but not enough to totally derail his candidacy as he would still likely place well with numerous victories across the South on March 1. A win in SC would really solidify his standing and give him momentum to nearly run the table March 1 (it is hard to see him win TX at this point). My guess is the polls showing him up 15% are overstating things and he likely wins by about 10%. At that point, it very much becomes Trump’s race to lose with a chance to take a commanding delegate lead and a head of steam after the SEC Primary, though if the field narrows to 2 after the 15th all bets are off. I would expect Trump to win tomorrow with the operative question “by how much.” I guess 9%.

Marco Rubio: Rubio has seemingly rebounded from his NH debacle thanks to a strong ground game, solid debate performance, and key endorsements from Rep. Trey Gowdy, Sen. Tim Scott, and Gov. Nikki Haley. With that popular trio, Rubio should be finishing very strongly in SC, even if NH derailed the “3-2-1” strategy (now it’s the less catchy “3-5-2/3”). The Rubio/Cruz battle for 2nd/3rd is very close, but Rubio appears to be the candidate with the momentum. These endorsements have given Rubio the shot he has at 2nd but raise the bar for success. 2nd place leaves Rubio in a very good position to consolidate the “establishment” and “center-right” lanes, become the clear anti-Trump choice, and win a few states (perhaps NV?) before picking up Florida’s 99 delegates the 15th. A solid 3rd gives Rubio some momentum and still leaves him the clear choice in anti-Trump circles. The problem for Rubio would arise if he came in a weak 3rd (say 15%). If that’s all he can muster with the institutional support he has in SC, it will raise reasonable concerns about where Rubio can win. A weak showing could let Bush continue, siphoning off votes on March 1, while leaving the anti-Trump part of the party fractured. In the worst case, Rubio, without any SC momentum, goes winless on the 1st and 8th, leaving him vulnerable to losing to Trump in FL, ending his bid. My base case is 2nd for Rubio, but he has to perform tomorrow, if he drifts much below 17%, yellow lights will be flashing.  15% is my benchmark for failure, which is not my expectation.

Ted Cruz: Cruz like Rubio needs a strong showing, and while I see him in a close third, his fantastic ground game could still get him in 2nd. The fact is Cruz needs to crush it on March 1 because the map gets very unfavorable after that. He should win big in TX, which could net him 100-120 delegates, but he needs some wins elsewhere in the South to wrest the anti-establishment crown from Trump as places like MI, OH, MO, FL, WI are unlikely to be as favorable as AL, TN, OK, and GA. If Cruz can’t win in the South, it is unclear where he could thereafter. A bunch of second place finishes to Trump would give him plenty of delegates and a chance in a brokered convention but would leave him with a challenged path to winning outright. Cruz needs to walk out of SC with some momentum so that he can challenge Trump on March 1. A win certainly would do that but seems unlikely. 2nd also leaves him with a decent shot, though he will need a good week campaigning and solid debate performance to hold Trump back. A 3rd place finish leaves Cruz in a weakened position, and something closer to 15% than 20% would be very problematic (though that seems unlikely). For Cruz to have a credible shot at the nomination, he likely needs to be the delegate leader after March 1. A weak SC showing makes that tough to envision.

Jeb Bush: Bush needs a top three finish to justify continuing his campaign. Besides running low on cash at the campaign level, he may not have much of a choice about how much longer he continues. After making SC a make or break state and bringing in his brother to campaign for him, a loss to Rubio would be very disappointing and lead to even more of a donor exodus. If he can beat Rubio, Bush will be able to stick around, though it is unclear when Bush would actually be able to win a primary. Anyway at this point, 5th place is likelier than 3rd. With money drying up and no momentum, Bush’s campaign will probably be done after SC, though he may take a shot at NV hoping to hit the proverbial jackpot. If he sticks around despite a poor finish, it will be nothing but a vanity effort with Bush too hobbled to have any credible chance at the nomination.

John Kasich: Kasich probably has the lowest bar of any candidate tomorrow as South Carolina has never seemed like a perfect fit, especially given the time and money Rubio and Bush have devoted to the state (full disclosure: I have donated to the Kasich campaign). I would look for Kasich to finish 5th, and it would be helpful for him to get to double digits to keep some of his NH momentum. Surpassing Bush, an outside possibility, would also help him in the expectations game. Kasich retains a narrow path to the nomination that doesn’t change much based on SC: use March 15 (a huge win in OH, strong showings/wins in MO and IL) to consolidate anti-Trump and start a big winning streak. That likely requires winning or a strong 2nd in Michigan on the 8th. To do that, I would argue he must show some viability on March 1, probably by winning or coming in 2nd in VT, MA, and maybe VA. It is a narrow path, and SC won’t derail it, but a finish above Jeb would be beneficial. One thing to watch for is a possible Governor Christie endorsement before March 1, which could bring other Governors (like MA’s Charlie Baker) on board and help Kasich score a better than expected showing on the 1st.

Ben Carson: There just is no plausible path for Carson to be the Republican nominee, and I would expect a 6th place finish, though thanks to committed supporters, there is an outside chance he sneaks into 5th. Ben Carson really seems to be this cycle’s Fred Thompson. In 2008, Thompson, who had no shot, stayed in through SC to pull votes from Huckabee and help his friend, John McCain win the state. It feels like Carson is sticking around to take votes away from Cruz, whose campaign spread a rumor he was dropping out in Iowa. By pulling over 5%, Carson does make Cruz’s life tougher, thereby helping Trump. Carson may stick around through March 1st, but if he does, it will only serve to hurt Cruz.

Ultimately, Cruz and Rubio are in somewhat precarious positions. Both need to exit SC with momentum to gain ownership of their lane. Strong showings put them in good positions to take on Trump, but weak showings could cripple them. I’m going to guess Rubio bests Cruz but both achieve what they need to. For Trump, a win solidifies his status as frontrunner, particularly if he can make it double-digits, but even a shocking loss leaves him with a path. Jeb is all but done, but Rubio needs to put him away. Carson is merely playing spoiler. Perhaps more than a strong performance of his own, Kasich is rooting for a bit softer Rubio performance to delay the consolidation of the establishment lane, making his narrow path a bit more plausible.

Of course, if these predictions are proven wrong in 24 hours, I will deny having given them. That does seem to work for our frontrunner after all…

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Iowa Thoughts and Implications

Finally after months of polling and debates, voters actually entered the process with Senator Ted Cruz delivering a bit of a surprise by defeating Donald Trump while Senator Marco Rubio came in a solid 3rd. As you can see from my tweet below, I both underestimated Rubio’s strength (he finished at 23%) and mixed up Trump and Cruz. With these results in hand, I’ve also adjusted my nomination probabilities with Rubio taking a slight lead over Trump and Cruz. Pre-Iowa, Trump sat at 45%, which reflected a 50/50 chance he would win the caucus, meaning his win probability was bound to move sizably one way or the other. Given his finish, his probability had to move lower while Cruz now has a clear path through the March 1 SEC Primary and Rubio is well positioned to consolidate “establishment” support. Below are some retrospective and prospective takeaways from Iowa.

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The retrospectives:

  1. Fundamentals matter: Trump tried to ignore the basic tenets of an Iowa campaign, forgoing a sizable ground game or paid media until the closing weeks whereas Cruz amassed a volunteer army and ultimately did a superior job of translating his support to votes. Trump is a unique candidate for sure but is not immune to political realities.
  2. Trump should’ve done the debate: Trump lost late-deciders 2 to 1 to Rubio, and his failure to attend the FOX debate is likely culpable for this deficit. Sure, he could’ve bombed at the debate and done equally poor with late deciders, but since he lost when skipping the debate, he had nothing to lose by showing up. A mistake.
  3. Bush and Christie wasted their time. Both men spent some time, which is a limited resource for all candidates, and money in Iowa but had nothing to show for it, finishing at 3% and 2%, no better than Kasich who eschewed Iowa to focus on New Hampshire. These two should have just focused on New Hampshire as well. Half-hearted campaigning in Iowa never works.
  4. Peak at the right moment. Marco Rubio soared the final week, which helped him exceed expectations and generate a positive media narrative. Had the caucus been last Monday, he would not have fared as well. Life and politics is all about timing.
  5. There are many anti-Trump voters. Turnout surged to 185k, which I would’ve guessed carried Trump to victory. While Trump brought many supporters into the process, he also seemed to bring detractors into it with Rubio and Cruz getting more votes than any previous Iowa winner. The intensity of opinions, both for and against Trump, means high turnout does not necessarily help Trump.
  6. Trump’s ego and big bet cost him. Iowa was never a good fit for Trump given its caucus structure and evangelical core. He could’ve credibly downplayed Iowa and focused on New Hampshire, perhaps only paying attention the final week to secure a stronger 2nd place finish and get a positive media story (a la Rubio). Instead, Trump’s winner take all attitude took hold and he went all-out to win an unfriendly state while publicly raising expectations, which backfired, leaving him more wounded than had he downplayed its importance. Now had he won Iowa, he would be the overwhelming favorite with a real chance of functionally running the table, so Trump decided to place a big bet on Iowa. That is understandable, but it didn’t work out, wounding the national frontrunner.

Prospective views:

  1. New Hampshire is make or break for Trump. Losing Iowa is not fatal for Trump given a 20% lead in New Hampshire (though it will likely shrink), and both Hillary Clinton and John McCain bounced back here after weak 2008 Iowa showings. With the establishment lane likely to stay somewhat divided next Tuesday, Trump should be able to prevail here even if his support dips below the current 30-35% level in the polls. NH is basically must win for Trump though. To lose this state given his current lead would seriously damage his narrative and could cause his voters in South Carolina to consider Cruz. While Trump could fight beyond NH should he lose, he would likely be a mortally wounded candidate with declining support. Conversely if he holds on, Trump will have a win on the board and some momentum headed into South Carolina and the South on March 1, which seem hospitable to him. Candidates inevitably face adversity, and this is Trump’s key test. His concession speech last night was gracious and suggests he is ready for the test. If he can pass it, Trump could exit New Hampshire in strong position. At this point, I think Trump is the clear favorite in New Hampshire.
  2. Rubio vs. the Governors. Bush, Kasich, and Christie will be going hard against Rubio who has a chance to consolidate the establishment lane in NH and get a strong second showing. The four are a combined 40-45% in most polls, so if Rubio could push their combined support down to 20%, he has a path to 25%, which should be good for a strong second place showing. The governors won’t go down without a fight and will likely focus on Rubio’s lack of experience, policy shifts, and lack of time in NH campaigning. Saturday’s debate will also be fierce. Christie is already fading, and Rubio is positioned to take many Bush supporters. Kasich supporters have a more independent bend and could prove stickier. Of the three governors, Kasich seems best positioned to fight Rubio for top of the establishment lane in NH. At this point, it seems likely Christie will drop out after NH, Kasich will barring a 2nd place or strong 3rd place finish, and Bush seems determined to stick it out through South Carolina despite his unviability. (NB: I have donated to the Kasich campaign)
  3. Rubio may want a Trump victory. Let’s say Trump implodes, leaving Rubio and Cruz as the two main remaining contenders. That would probably translate to a romp on March 1 when the South votes with a good chance Cruz could nearly sweep, especially with his large cash balance and strong organization. Cruz is simply a better fit for the South than Rubio and could rattle off numerous 60-40% victories that night. While the delegates are proportional keeping Rubio close, Cruz could have a head of steam that gives him momentum when less hospitable states start voting March 15 and later, propelling him to upset victories. While Rubio could fight it out for a while, Cruz’s momentum could leave a Rubio charge coming up short. However if Trump wins NH, he would be viable on March 1, likely splitting the vote with Cruz. This could lead to numerous victors and help Rubio carry some states in the SEC. Suddenly, Cruz would not have the same momentum, and when March 15 rolls around, Rubio would be positioned for a bigger night, and buoyed by Florida’s 99 delegates, on a cleaner path to the majority. It is hard to argue that winning NH is bad for Rubio, but he could still be very well/better positioned should he finish 2nd to Trump. The presence of both Santorum and Gingrich helped Romney; the same could be said of Trump and Cruz for Rubio (though Trump and Cruz are more formidable and Rubio has wider appeal than Romney).
  4. Rubio is the frontrunner. The establishment hates Cruz, and Trump’s favorability numbers are not great. Meanwhile, Rubio is well positioned to consolidate the establishment (not that the term means much) lane with a strong NH finish. Rubio has the momentum to force Christie out after NH, and while Jeb is not viable, he will likely stick it out until South Carolina. Kasich voters could prove tougher to cannibalize this week, and Kasich could play well in the Upper Midwest if he shows well in NH, the one thorn in Rubio’s side. Otherwise, Rubio appears the most acceptable candidate to the broadest swath of the party. While Cruz and Trump may be dividing and conquering, Rubio has a path to sneak by them by March 15, by consolidating the establishment lanes and holding close on March 1. If he can do that, the map becomes quite favorable. It is still early and very uncertain, but I would prefer to be in Rubio’s position than anyone else’s.

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What Happened to Optimistic Conservatism

Over the past week, we have witnessed the Obama Presidency collapse upon itself. From the attacks in Paris showcasing how we have underestimated ISIS, to the fact Iran has increased its stockpile of enriched uranium since agreeing to the nuclear deal, to UnitedHeath considering exiting Obamacare exchanges due to massive losses. Even a key Obamacare architect concedes the insurance plans stink and that costs haven’t been controlled. All the while, Obama, the man who ran promising to end the politics of old and unify the country, has taken his rhetoric to new lows, suggesting Republicans are ISIS recruiters while dismissing a terrorist attacks as a “setback.” The President apparently thinks failings are due to the fact the office of the Presidency “is weak.” A more likely explanation? The man in the office is weak.

In 2016, the Democrats will almost certainly put forth Hillary Clinton who helped architect our naïve and misguided foreign policy that is in total ruin. On top of this, her forthrightness on the issues leaves just a bit to be desired. Given failed policies and the historical challenges of winning three straight terms, 2016 should be a prime opportunity for conservatives to retake the White House and set the country back on a proper trajectory. Polls this far in advance are of little import but show a close and very winnable race, yet I fear there is increasing reason to be worried that once again we will steal defeat from the jaws of victory.

Before your eyes glaze over in anticipation of reading the 14,714th piece on how the GOP needs to do better with Hispanics or women, that is not my focus (either you agree or disagree with that argument, nothing I say will sway you). My concern is more fundamental. The republican electorate is increasingly pessimistic about the future of the country. Conservativism is an innately optimistic political philosophy, and we need to instill optimism if we are going to win. Yet according to the Public Religion Research Institute (in a poll of 2,700), only 41% of republicans and 33% of Tea Party members think America’s best days are ahead of us.

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Clearly, the disaster that is the Obama Presidency is weighing on sentiment, and that isn’t surprising; voters’ anger is palpable. At the same time, republican candidates can’t merely play into this pessimism; they need to offer a compelling and hopeful vision about the future. This was a key failure (there were several) in Mitt Romney’s 2012 campaign. While he prosecuted the case against Obama well, he did not articulate what he would do going forward in a compelling fashion (which boggles the mind given how gifted his running mate, Paul Ryan, is at doing precisely that). It is a fatal error to take a pessimistic tone to voters because it is at odds with our beliefs. Liberals are pessimists at heart, though Obama did a masterful job in 2008 portraying himself as an optimist, helping win the nomination and cruise to the Presidency. I would argue that ultimately voters, even angry ones, want to believe better days for the nation are ahead. To give this ground is mistaken, particularly when our future actually is bright. Saying better days are ahead isn’t merely wise politics, it happens to be the truth! We are too great a nation to accept inevitable decline.

To be conservative is to believe that power and decision-making is best left in the hands of individuals through lower taxation, less regulation, and local control. In other words, we think ordinary people make better decisions than a bunch of so-called experts in a centralized bureaucracy, which implies a positive view of the competence and judgment of people. To support more control at a centralized level, as liberals propose, suggests they don’t trust the public to make decisions. Generally, one thinks less of a person whom one does not trust. This dichotomy is the core disagreement between liberalism and conservatism: do you put your faith in people of bureaucracy? Whether you have a positive or negative view of the public’s competence is a driver of your answer. If you have confidence in the public (as conservatives inherently do), it is then questionable to think the nation’s best days are in the rear view mirror.

This optimist/pessimist divide permeates further. Liberals are now obsessively focused with income inequality. They have all but written off attempts to grow the pie and are laser-focused on re-slicing it. They see an America that can’t be the global leader (heck, Hillary Clinton doesn’t even think the US should lead the fight against ISIS), as though our time as a Super Power able to roll back the evil of communism was a mere flash in the pan, destined to burn out. The core of the democratic platform is basically: we can’t grow so let’s take from the rich to help the poor and abdicate global leadership. This is the platform of people who think America’s best days are behind it. It is also the path of Europe, which chose to enter blissful decline 40 years ago (though it is now realizing that decline isn’t so blissful when debts are high and innovation lacking) and is now on a path to irrelevance in global affairs.

It is still early, but republican candidates have not done a particularly good job laying out an optimistic vision. Much of this is due to the Donald Trump phenomenon. He spends much of his time tearing down opponents, and his policy statements are negative like “wages [are] too high” or “the American dream is dead” (both from the Fox Business Debate…Trump has subsequently claimed he was only speaking to the minimum wage, though he repeated the wage line elsewhere). The recent controversy over a national Muslim registry shows a candidate who plays to our worst fears rather than our greater aspirations. Given multiple chances to walk back that statement, Trump continues to suggest an openness to it, most recently on This Week. Let’s be clear: rounding up and registering people of a certain faith isn’t conservative, it is evil, cruel, and fascist. For a candidate pledging to “make America great again,” it would be hard to argue Trump has run a hopeful, optimistic campaign, and in the process, he has lowered the discourse in our primary debate. I would suggest other candidates like Ted Cruz have let anger overwhelm optimism, and many who are supposed optimists like Jeb Bush come across as impotent. In fairness, Marco Rubio has been the candidate who has done the best job in the field laying out an optimistic vision for the country.

In particular, he has turned the immigration issue on its head to prove the greatness of the country. From The O’Reilly Factor: “I think America is great. You know how I know it’s great? You don’t have American refugees winding up on the shores of other countries. You actually have people wanting their children born here. America is a great country. The issue is: We could be even greater. We are not fulfilling our potential.” Conservatives everywhere should copy this down.

Now, admittedly, it can be challenging to put forth an optimistic vision when the other party is in control because if things are going so great, you should stick with them. There is a necessary balancing between saying things not being great today but have the capacity to be great in the not too distant future. There is a nuance to it that can be lost in a news cycle obsessed with 30 second soundbites. While I caution republicans from discussing the Reagan legacy too much since most Americans did not vote in the 1980 election (it was 35 year ago), there are lessons in his rhetoric that are still applicable. He succinctly framed all elections in one simple question: “Are you better off than you were four years ago?” This is an excerpt of his answer in that debate with President Carter (emphasis my own):

This country doesn’t have to be in the shape that it is in. We do not have to go on sharing in scarcity with the country getting worse off, with unemployment growing. We talk about the unemployment lines. If all of the unemployed today were in a single line allowing two feet for each of them, that line would reach from New York City to Los Angeles, California. All of this can be cured and all of it can be solved…I would like to have a crusade today, and I would like to lead that crusade with your help. And it would be one to take Government off the backs of the great people of this country, and turn you loose again to do those things that I know you can do so well, because you did them and made this country great. Thank you.

Reagan’s campaign was predicated on the argument the American people were great, and it was the government holding them back. By rolling back government and freeing the public from the shackles of high taxes, regulation and inflation, the country would flourish again. His was a campaign of hope not hatred, appealing to the intrinsic decency and aspiration of every individual. It was a theme he expounded upon in his Inaugural Address (emphasis added):

It is no coincidence that our present troubles parallel and are proportionate to the intervention and intrusion in our lives that result from unnecessary and excessive growth of government. It is time for us to realize that we’re too great a nation to limit ourselves to small dreams. We’re not, as some would have us believe, doomed to an inevitable decline. I do not believe in a fate that will fall on us no matter what we do. I do believe in a fate that will fall on us if we do nothing. So, with all the creative energy at our command, let us begin an era of national renewal. Let us renew our determination, our courage, and our strength. And let us renew our faith and our hope.

We have every right to dream heroic dreams. Those who say that we’re in a time when there are not heroes, they just don’t know where to look. You can see heroes every day going in and out of factory gates. Others, a handful in number, produce enough food to feed all of us and then the world beyond. You meet heroes across a counter, and they’re on both sides of that counter. There are entrepreneurs with faith in themselves and faith in an idea who create new jobs, new wealth and opportunity. They’re individuals and families whose taxes support the government and whose voluntary gifts support church, charity, culture, art, and education. Their patriotism is quiet, but deep. Their values sustain our national life.

Now, I have used the words “they” and “their” in speaking of these heroes. I could say “you” and “your,” because I’m addressing the heroes of whom I speak — you, the citizens of this blessed land. Your dreams, your hopes, your goals are going to be the dreams, the hopes, and the goals of this administration, so help me God.

This optimism and unyielding faith in American public was the cornerstone of Reagan’s political philosophy and career. It is only fitting that in his final remarks to a Republican Convention in 1992, he poetically ratified this political doctrine (emphasis added):

A fellow named James Allen once wrote in his diary, “Many thinking people believe America has seen its best days.” He wrote that July 26, 1775. There are still those who believe America is weakening; that our glory was the brief flash of time called the 20th Century; that ours was a burst of greatness too bright and brilliant to sustain; that America’s purpose is past.

My friends, I utterly reject those views. That’s not the America we know. We were meant to be masters of destiny, not victims of fate. Who among us would trade America’s future for that of any other country in the world? And who could possibly have so little faith in our America that they would trade our tomorrows for our yesterdays?

Republican candidates and pundits can spend so much time waxing nostalgically about the Reagan era it can feel like they would trade our future for our past. This tendency, coupled with such an angry, divisive campaign, can leave people thinking the best is behind us, especially considering the crumbling of the Obama Presidency we are witnessing. This is a problem, and we will not win if we cannot put forward a credible and compelling vision for the country. Unfortunately, we are constantly sidetracked by the boorish shenanigans of Trump who is either lobbing insults, threatening to sue, or more recently maligning Muslims. We are a movement that believes in Shining Cities not Gestapos, and he is a charlatan masquerading as a conservative. We need to start aggressively calling him out for it.

Democrats have mastered identity politics, dividing voters against each other to cobble together winning coalitions. To combat this, republicans shouldn’t try to beat them at their own game but offer a unifying message, which is more constructive when it comes to actually governing. Rather than betting on government to manage the decline, I want to bet on the public to make this a better country. It has been a winning bet for over two centuries, and while we are suffering from abject incompetence in the White House, I see no reason to stop placing this bet. Where are the world’s greatest new companies from Facebook to Uber built? What country has the most hard-working, innovative citizenry? What country serves as the inspiration for the oppressed in the world? The questions can go on and on, but the answer remains the same: the United States.

Do we have challenges? Obviously, from a broken entitlement system to stagnant wages to an aggressive China and resurgent Russia. These challenges are not unusually grave, and we are better positioned than any other country on the earth with a better mix of personal freedom, economic ingenuity, military might, and demographics than any other nation. Without a shadow of a doubt, our best days are ahead of us. Decline is a choice not a sentence. Conservatives need to renew our faith in the future of the country. There is no reason for 58% of republican voters to feel like our best days are behind us. That is a failure of our political leadership to lay out a compelling vision. We need to move away from angry rhetoric, rebuke Trump’s asinine assertions, and once again explain our faith in the American people and how returning money and power to them can undo the damage Obama has done.

Pessimistic conservatism is a non-starter and ideologically inconsistent. We can express anger at the failings of the Obama/Clinton policies while also pivoting to an optimistic agenda that ensures brighter days are ahead. It’s the only way to win.

Taxing in the 21st Century

Several Republican Presidential candidates (Trump, Bush, Rubio, Paul, Kasich, Jindal, Santorum, and Cruz to name a few) have outlined fairly specific tax plans aimed at accelerating U.S. economic growth. Most follow a similar pattern of eliminating deductions and lowering rates, which has worked quite well in the past (the Reagan Recovery being the standout example as seen in Chart 1). While the impulse to dust off the Reagan playbook is quite strong given the empirical data, conservatives really need to aggressively rethink how we tax and be careful not to knee-jerk back to past solutions. It is on this point where Sen. Ted Cruz’s tax plan stands out and should be applauded. While I have reservations about how the specifics of his tax plan, he has shown the greatest willingness to move away from the orthodoxy and rethink the nature of our tax code (more on his plan will follow)

Chart 1

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With each passing day, the Reagan era grows more distant (an admitted redundancy that is still important to remember), and reflexively returning to his playbook is fraught with political danger (more and more voters were not old enough to cast a ballot for him) and policy danger. Conservatives need to do a better job delineating solutions from principles. Principles are what we believe (and as such are relatively unchanging) whereas solutions are how we implement principles (and as such change as the problems change). It is a disservice to Reagan’s legacy to simply suggest cutting marginal rates is the best answer to a slow economy as this implies there is a magic formula that would solve any problem.

The genius of the Reagan Administration was its ability to take conservative principles and apply them to policies to craft specific solutions to the problems of the day. We need to keep these principles, but today’s problems may necessitate different solutions. In brief as conservatives, we believe in returning power to the individual and away from the collective. Ultimately, individuals make better decisions regarding their own lives than a bunch of bureaucrats can hope to. This means entrusting power in the people and keeping government interference to a minimum.

Armed with these beliefs, Reagan focused his tax relief on capital. In 1981, the US was suffering from high unemployment and high inflation (stagflation). Reagan took over an economy that was treating capital poorly. As can be seen in the following chart, labor was gaining share in the economy—at the expense of capital, leading to a retrenchment in investment. There was a supply of capital crisis. When capital is treated poorly (ie 70% marginal tax rates and windfall profit taxes), holders of capital are less likely to invest it. When you don’t see capital investment, an economy grows too tight, sending prices skyrocketing (Chart 3, NB inflation is inverted). As prices soared, consumer confidence fell, leading to less spending and subsequently an even worse environment for investing.

Chart 2

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Chart 3

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Recognizing the supply problem the economy faced, Reagan freed up capital by rolling back regulations and focusing tax cuts on top marginal rates (bringing them down from 70% to 50% and later 28%). Reagan’s capital-aimed economic policies worked remarkably well, bringing inflation down and consumer confidence back (Chart 3) while economic growth soared (Chart 1). Reagan took conservative principles (empowering the individual rather than the collective) and applied them to the problems of the day (unfavorable policies inhibiting capital and causing an inflation shock) to create policies that bettered the lives of Americans.

Fast-forwarding to the present day, we have conservatives offering a variety of tax plans aiming to spur growth. When looking at tax plans, we need to drill down to the basics and ask the question: why we tax? The answer is simple: to fund government expenditures. There are some things government must spend money on (ie defense), and we cannot sustainably borrow money to pay for everything. Depending on the speed one wants to bring down our debt load, tax revenue likely needs to be 17.5-20.5% of GDP on average over the medium term.

It then becomes a matter of constructing a tax code that has the best impact on the economy over the medium term. In a sense, offering a tax break to one group needs to be offset by taxing another group; for instance, opting against an estate tax (which many conservatives call for) would cost revenue that needs to be made up elsewhere. On the other hand, eliminating ineffective deductions (the deductibility of corporate interest expense perhaps?) helps to fund tax breaks elsewhere. Ultimately, we would build a tax system that generates the necessary revenue while having the best economic impact, and this tax code could be dramatically different from our current convoluted mess (spoiler alert: it would be).

Most importantly, the efficient tax code would change over time because our economy is ever-changing. While conservatives should continue to push for as low of a tax burden as possible with a simple code that leaves individuals with as much power as possible, how that translates into marginal rates, deductions, and so forth can change a bit. Reagan faced an economy that treated capital poorly, and so, he lessened capital’s tax burden. Today’s economy is far different. Under Obama (as you can see in Chart 2), labor has done absolutely terrible, losing share to capital. This decline helps to explain why aggregate economic statistics (like 5% unemployment) seem out of whack with how most in the middle class feel. As such, it is critical to build a tax code that incentivizes work to get people back into the work force and working. This requires creative thinking from expanding the earned income tax credit, to contemplating the implications of a negative marginal tax rate bracket, and closing loopholes that provide little economic bang for the buck.

On the whole, it is hard to look at most of the Republican tax plans and not believe they would be better than the status quo, though none is without flaws. Most plans (like Rubio, Bush, and Kasich) stick relatively close to traditional conservative orthodoxy, but Cruz’s stands out. Cruz basically throws out the current system, has a 10% income flat tax, and a 16% business flat tax. Per the Tax Foundation, the Cruz plan costs about $3.6 trillion over a decade, but based on their view that the economy will be 13% larger (a plausible but definitely not unfriendly view), they see it only costing $770 billion. The US, in aggregate, is certainly not under-taxed, so there is nothing wrong with a tax plan that offers a moderate tax cut like Cruz’s does. I would note (that based on my rudimentary number-crunching) most of the growth driven revenue gains would be realized at the back end of the decade with years 9 and 10 generating up to $1 trillion of the incremental $2.8 trillion in revenue. Essentially, the revenue hit is not $77 billion/year, rather, it is much larger upfront and shrinks, possibly even gaining revenue at the tail end.

At first glance, it looks like Cruz provides labor with a massive tax cut, given the low 10% rate that for a family of 4 kicks in after 36k. However, his business tax would tax both profits and payrolls. So an employee earning $100,000 would pay a 10% flat tax, but his employer would also pay a 16% tax ($16,000). Under current law, the Social Security payroll tax is only 6.2%, so Cruz is really using a tax increase on payrolls to fund cuts elsewhere. Frankly relative to current law, Cruz is providing a dis-incentive to employee people.

Alongside this, Cruz would allow for the immediate expensing of equipment. Put in simple terms, buying a robot would not be subject to a 16% tax but hiring a worker would be. We continue to see a push towards automation in the economy. While painful for the worker being automated out, this is a good thing. I think we would all agree that on net ATMs have been a positive, even though they were a negative for bank tellers. Businesses should automate when the underlying economics make sense, but we don’t want decisions being made for tax purposes. An economy functions most efficiently when capital is allocated based on underlying economics and not tax implications. When taxes start changing allocation decisions, a government is picking winners and losers, which more often than not ends badly (how’d that Solyndra loan work out?).

Now, the government should not actively impede automation as this would leave the US poorly positioned in world trade and slow growth. The tax code should be neutral on the matter, and let economic reality be the determinant. Amazingly, this is one of the few things our current code does somewhat well. Employers pay a payroll tax but can deduct payroll immediately while purchases of equipment are deducted over multiple years (ignoring temporary tax breaks). When calculating the present value of the tax implications of the decision (a worker or machine), they roughly cancel out (or come fairly close), meaning that business owner would choose the economically wisest.

Cruz’s plan tilts the playing field away from workers and towards capital, incentivizing automation. Now if the pre-tax economics of hiring a worker or automating are the same, a business would choose to automate because it receives more favorable tax treatment. Interestingly, there is a pretty good case to be made that this plan would have worked particularly well in 1980 when the cost of capital was too high. Similar to Reagan’s steep marginal rate cuts, the Cruz plan would incentivize investing and have increased aggregate supply to bring inflation under control.

While Cruz’s plan benefits from original thinking, it solves past problems and would likely exacerbate the trend in chart 2 where labor has lost ground under Obama. This is one reason why I think the Tax Foundation’s growth expectations could be a bit optimistic. The Foundation does say the capital stock rises 44%, which makes sense as lower taxation would create more capital. The fact it grows 3x the economy does show the diminishing return of excess capital in the current environment. In fact, the issues with our capital stock could be dealt with more simply and just as effectively in two strokes. First, stop taxing repatriated profits at 35%, which would bring back $2 trillion. Second, Dodd-Frank has disincentivized bank lending, and as such, banks are carrying $2.5 trillion in excess cash. Roll back some of these regulations, and banks would be free to increase lending to small business and others, which would push growth faster.

Cruz (and others) are fighting the last war, focusing tax cuts in places where they will provide less growth. Reagan’s ingenuity was not that he lowered taxes but that he recognized the problems he was facing and structured his tax cuts in a way to solve those problems. Labor and capital supply an economy, and he faced a capital crisis. By fixing that, he put us on a path for 25 years of prosperity. Today, capital is doing well, and our crisis is on the labor front. Labor force participation is lower than it should be, wage stagnation is real, and capital has done fairly well with the top doing very well under Obama (who has helped exacerbate the very inequality he rails against). Again, the solution to this problem is not to punish the top to subsidize everyone else as that slows growth over time. However while Reagan tried to stimulate capital, we need to stimulate labor. This means debating a larger EITC, considering negative marginal rates, incentivizing job training, and eliminating certain loopholes (like carried interest and interest deductibility) to fund lower marginal rates. It also means keeping capital gains taxes and rethinking total opposition to the estate tax (or at least the stepped-up basis).

Reagan’s principles and the tenets of supply-side economics are as relevant as ever, but conservatives need to engage in further debate about how those principles apply to today’s challenges. The best answer could be wholesale change to the tax code (like Cruz has boldly suggested) or sticking a bit closer to the status quo. Taxes at the end of the day are a means to an end, a way to fund government while creating the conditions for the most robust growth. This requires an analysis of what breaks provide the least value and what taxes slow growth the most in today’s economy (and then eliminating those breaks to fund the elimination of those taxes!). It also requires a deeper debate on what part of the supply curve needs the stimulus. Admittedly, stimulating labor, without doing so at the expense of capital, is a challenge but not an insurmountable one (pairing labor-focused cuts with fewer deductions, a quasi-territorial corporate system, modified Dodd-Frank, and reformed estate tax is our best bet in my estimation).

Conservatives need to do a better job explaining how our principles and faith in the American people rather than government translate into solutions for today and are not merely regurgitated answers to the problems of 35 years ago. That is a pre-requisite for winning elections, and more importantly, it is the only way to actually make the American public better off. Re-examining our tax orthodoxy is a good place to start. Hats off to Senator Cruz for doing just that. While I would question the specifics of his plan, he is starting a debate we very much need to have.