Trickle down economics

The UK government’s economic policies under new PM Liz Truss have caused a stir among, not only leftists, but also among mainstream economists.  The new government says the solution to the stagnation and failure of British capitalist production is to cut taxation on the rich and on big business.  The extra income flowing to them will then be available to boost investment and spending that can deliver economic growth.

This is a reversion to a very old idea in neoclassical economics: trickle-down economics.  The term “trickle-down” originated as a joke by humorist Will Rogers  which he used to criticize economic policies that favoured the wealthy or privileged while being framed as good for the average citizen.

Trickle-down economics is often seen as part of what economists call ‘supply-side economic policies’ which argue that it is failures in production, not demand that is the problem for capitalist production.  What the supply-side boys and girls want is a ‘flexible’ labour force and higher productivity from more investment; not macro demand management that Keynesians claim is the answer. 

In particular, trickle-down theory more specifically advocates for a lower tax burden on the upper end of the economic spectrum in order to boost incomes for those who will save and invest more.  That’s just talk for raising profits for business to the detriment of wages in order to encourage investment.  Increased income and profit for the rich will eventually trickle down to the rest of us when the rich spend their money or invest in their businesses.

Leading mainstream supply-side economists like Thomas Sowell reject ‘trickle down’ as part of supply-side theory or policy.  Sowell: “Let’s do something completely unexpected: Let’s stop and think. Why would anyone advocate that we “give” something to A in hopes that it would trickle down to B? Why in the world would any sane person not give it to B and cut out the middleman? But all this is moot, because there was no trickle-down theory about giving something to anybody in the first place.”

The theory is really an economic child of the extreme right-wing philosophy of Ayn Rand, the American who reckoned that the rich should rule without restriction, the gormless masses should follow them and that greed is good.  Indeed, this philosophy permeates British PM’s new economic advisors.  One such is Matthew Sinclair, formerly chief executive of the right-wing misnamed Taxpayers’ Alliance.  This is funded by unknown foreign donors. Sinclair wrote a book called Let Them Eat Carbon, arguing against action to prevent climate breakdown.  He claimed that: “Equatorial regions might suffer, but it is entirely possible that this will be balanced out by areas like Greenland.” So that’s all right then; as those in the Global North will be fine, even if billions of poor people in the Global South fry or drown.

However, the theory that cutting income taxes will raise revenue often gains support from the liberal mainstream.  John F. Kennedy argued that tax rates can be so high that they can have an adverse effect on the economy.  In a 1962 address to Congress, John F. Kennedy said, “it is a paradoxical truth that tax rates are too high today and tax revenues are too low and the soundest way to raise the revenues in the long run is to cut the rates now.”  And John Maynard Keynes said, back in 1933, that “taxation may be so high as to defeat its object,” that in the long run, a reduction of the tax rate “will run a better chance, than an increase, of balancing the budget.”

But is it true that cutting taxes could actually raise government revenue rather than reduce it? You can see the theory.  The right-wing ‘trickle down’ advocates reckon that lower taxes for the rich will bring more investment and spending and so more jobs and income for all ie supply-led growth.  The liberal advocates reckon that cutting taxes (for all) will mean ‘middling up’ as average incomes will rise and there will be more spending.  This extra demand will lead to businesses expanding: ie demand-led growth.

But what is the empirical support for ‘trickle down’ or even ‘middling up’?  The leading economic advocate of the theory that cutting taxes will lead to more growth and thus more, not less, government revenue was Arthur Laffer.  But even he thought that was true only if tax rates were above 50%.  Others reckoned it would be more like 70%. 

Actually, in the 1950s, personal income tax rates reached 80-90% at the top rate.  This did not seem to affect the fastest growth rates in capitalist economic history in North America and Europe then.  Yet the new British government now claims that cutting the already low top rate from 45% to 40% will boost growth and revenues.

The empirical evidence is just not there for the ‘trickle -down theory or the Laffer curve. Analysis published in 2012 by the Congressional Research Service found that reductions in top tax rates were not correlated with economic growth  Instead they were much more associated with rising income inequality. A 2012 study by the Tax Justice Network indicates that wealth of the super-rich does not trickle down to improve the economy, but it instead tends to be amassed and sheltered in tax havens with a negative effect on the tax bases of the home economy.  A 2015 paper by researchers for the International Monetary Fund argued that there was no trickle-down effect as the rich get richer: “[I]f the income share of the top 20 percent (the rich) increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20 percent (the poor) is associated with higher GDP growth.”

A 2019 study in the Journal of Political Economy found contrary to the claims of trickle-down theory that “the positive relationship between tax cuts and employment growth is largely driven by tax cuts for lower-income groups and that the effect of tax cuts for the top 10 percent on employment growth is small.”  Finally, a 2020 working paper by London School of Economics and Political Science researchers compared the results of countries that passed tax cuts in a specific year with those that did not, over a five decade period from 1965 to 2015 in the 18 member countries of the Organisation for Economic Co-operation and Development. It found that contrary to the claims of trickle-down theory, tax cuts for the rich had no “significant effect on employment or economic growth”. They found no evidence that the cuts induced “labour supply responses” from high-income individuals (i.e. “lead to more hours of work, more effort, etc.“) that boosted economic activity. On the other hand, they did find evidence of a “sizable” increase in income inequality. “Major tax cuts for the rich increase the top 1% share of pre-tax national income in the years following the reform. The magnitude of the effect is sizeable; on average, each major reform leads to a rise in top 1% share of pre-tax national income of 0.8 percentage points.”  Indeed, it was under PM Liz Truss’ hero, Margaret Thatcher from 1979-90 that inequality of income rose the most as she cut personal and corporate taxes. 

These tax cuts did not produce faster growth than in the golden age period of 1948-64 when these tax rates were high; and ironically, the tax burden as a % of GDP did not fall either because GDP did not rise enough to surpass increased revenues from other taxes.

In my view, it is obvious that just cutting personal income tax or even corporate profit tax will have little effect on economic growth.  What matters for growth is increased productivity of labour and that depends on increased investment in technology.  That in turn under capitalism depends on rising profits and profitability.  If they are falling or low, then even large adjustments in income tax will have limited effect compared to changes in overall profitability.  And remember the bulk of tax revenues no longer comes from personal or corporate taxes, but from sales or value-added taxes, customs duties, social security deductions and so-called stealth taxes. 

The IMF has argued that “increasing the income share of the poor and the middle class actually increases growth” and that “to tackle inequality …policies should focus on raising human capital and skills and making tax systems more progressive…” . Here the IMF is half right and half wrong.  Reduced taxation on working people might marginally reduce inequality of income but economic growth depends not on rising household incomes or spending but on profits and investment.  The cause and effect is, from profits to investment and growth; not from spending to profits and growth. Trickle-down or middle-up?  Neither can change much when it comes to economic growth.

15 thoughts on “Trickle down economics

  1. Pardon the unwelcome intrusion, but Sowell genuinely regarded as a mainstream economist? Are the economics departments of universities really in such a state? I knew that von Hayek was somehow regarded as a serious thinker but he had an official government position and an extensive network of financial backers and ideological allies (like the Mont Pelerin Society.) Sowell had what, a sinecure at Hoover Institution and tokenism?

    The article linked too is correct that Wilson, Kennedy and Keynes, all impeccably credentialed liberals, were willing to spout unsupported nonsense…but the moral is that liberal is not the same thing as left and hasn’t been since Edmund Burke managed to be both a leading Whig and one of the philandering fathers of Tory conservatism. Liberalism isn’t what it’s cracked up to be.

      1. Since you ask…whether Thomas Sowell really counts as a highly considered mainstream economist rather than a hired propagandist? (See his book on “Marxism.”) And that liberalism is premised on the notion that there must be capitalists to “give” us jobs and therefore isn’t left-wing at all.

  2. The situation of the UK is insoluble and irreversible. Its capitalism cannot be revived because it is a very small country with very few resources and, for the same reason, there’s no material base for a communist revolution there either.

    It is possible though that Labour comes back to power. Historically in the postwar era (1945-), the Tories are treated by the British people as the “default party” to rule the nation, and Labour as the extraofficial opposition. Labour is only elected to national power when the Tories make a major screw up for a long period of time, occasion where the British people uses Labour as a “punishment” to the Tories. This is the situation we’re witnessing now, with the Tories plunging the UK into economic chaos after one decade in power.

  3. Very good article. Of course, I share the notion that the drive of accumulation is profitability and the mass of surplus value before taxes. With this approach, it is perfectly understandable how in the golden age the capitalist private sector was able to withstand higher tax rates and, at the same time, growing faster. I would only like to point out two things: 1) both direct and indirect taxes imply surplus value deduction: if value added taxes were eliminated, for example, the mass of surplus value appropriated by the capitalist private sector would grow (hence profitability) but not they would lower the prices of consumer goods or increase real wages; 2) Although it is true that a decrease in taxes does not necessarily compensate for a decrease in the profitability of capital, it can be argued that the rate of accumulation would be even lower if taxes did not decrease. In other words: the trickle-down theory is incorrect because the law of profitability cannot be counteracted with fiscal policy, but the fact that less fiscal pressure equals more surplus value available for accumulation in the capitalist private sector cannot be denied.

    1. I’ve already made the faux pas, so….

      On point 1, I do not understand how sales taxes paid by workers are a deduction from surplus value, for one example. Nor is it clear to me that all businesses could determine their prices to capture all the surplus value previously extracted by value-added taxes. The scheme to suspend excise tax was not expected to leave gasoline prices unchanged, all the revenue appropriated by the oil companies et al. and I must say this seems to be correct.

      On point 2, I believe that some government spending is infrastructural investment, and this does contribute to lowering the cost of constant capital. I gather Marx didn’t spend much time on it, but as far as I can tell he acknowledged that increasing turnover time (something transportation and communication do) increases profit rates. Public education etc. also I think ends in raising the rate of surplus value by multiplying the productivity of labor. At least simple provision of water and sewage promote the existence of a labor force. No country has ever had all its roads provided by toll companies nor has any ever had its whole population educated in private schools.

      The general Reinhart and Rogoff perspective, where taxes are at the expense of accumulation, strikes me as wildly wrong. The bugaboo of “scarcity” is meant to imply anything less than market optimum is unthinkable, so far as I can tell. The conclusion planning is suicidal is rarely spelled out but seems to me to be the point, false premise meant to exclude unwelcome conclusions.

    2. Somehow I forgot to mention: Historically as near as I can tell taxes on landed property have served capitalist accumulation. In contemporary times, nor is it clear to me that taxing capitalist luxuries can do anything but promote accumulation, were the picture of a crying need for capital correct. Hundreds of millions for doomsday retreats or superyachts instead of a factory? Or a hospital? The truly pressing levels of taxation are associated with war, but war economy as such has not historically expropriated the capitalist class. Losing the war does (see: hyperinflation.) But that’s not the same thing, is it?

      1. stevenjohnson,
        1) It is common on the reformist left to assume that reducing or eliminating indirect taxes, on the one hand, and increasing direct taxes (on profits or wealth) can significantly improve the terms of income distribution. However, both for Ricardo and for Marx, wages in the long run are given and, therefore, taxes always imply deduction of surplus value or gross profits. The tax technique, that is, the way in which the bourgeois state collects taxes does not modify this reality. I recommend that you read the following note:
        I trust that you will understand using the translator, if you don’t know spanish.
        2) I think you misread what I wrote about taxes having a negative effect on capitalist accumulation. But I have been emphatic in pointing out that taxes negatively affect not accumulation in general but accumulation in the capitalist private sector in particular, in the sense that they will have less surplus value available for accumulation.

      2. Land tax is probably the oldest tax in History, and is not the source of capitalist accumulation.

        Tax is the mere manifestation of imperium by any kind of leviathanic formation (often anachronistically called “State”). It is violence turned wealth.

        What you meant was land rent, which is crucial not only to capitalist accumulation, but its very existence.

  4. The web page RealTime Inequality shows a shift in income distribution from 1976 to 2022 (real-time). During these 46 years in the U.S. the top-earning 10% has increased its share by 12.3% of total income, about $2.3 trillion. If the shift had not happened then the average income gain today for all households in the lower 90% would be approximately $20,000 (which would double the income of the lower 20%, add 54% more income to the next 20%, and add 36% to the middle 20%, and so on). The top marginal rate in 1963 was 91%, and in 1988 it was 28% — all in the name of trickle down. And the demise of labor power also coincided. RealTime is a product of U.C. Berkeley economists, it’s a neat visual treat. The book The Middle Out, the rise of progressive economics, by Michael Tomasky is a recent argument for all the policies to reverse the income distribution. The RealTime page shows that for 50% of adults in the lower half, income increased by $5,000, for the next 40% by $39,000, for the top 10% by $260,000. The lower half have $20,000 income (up from $15K), the 40% have $94K (up from $56K), the last 10% have income of $413K (up from $156K). The ratio from lower 50% to top 10% doubled from 1 to 10 to 1 to 20. It’s a national disaster. For instance an August 2022 survey from Robert Wood Johnson/Harvard U. states that about 40 to 45% of adults report difficulty paying basic expenses. My blog, Economics Without Greed, has a long essay about this, that’s why I can go on and on. The bright spot is the Supplemental Poverty Measure showing 2021 the poverty rate fell significantly, but that was last year, and the Child Tax Credit expired on Dec. 31, and other supports also.

  5. Increased incomes, at the lower end of the economic spectrum, leads to greater disposable income(when monopolies are not allowed to exploit though price gouging) and greater demand,thus larger profits and investment opportunities(capitalists raison d’etre is always greater profits). The key is for the State to create demand through market regulation and allowing markets to grow only where there’s a genuine economic competition.

    1. Markets do not tend to competition. Neither genuine nor otherwise. Is it so difficult for you to observe that all current markets tend towards monopoly, being today in a clear situation of oligopoly? The markets, the capital, the economic subjects only tend towards concentration. And they do so for various necessary reasons, especially economies of scale. Reasons and data that are essential to know in order to carry out certain economic analyzes.
      The State as a regulator that allows competition? The real empirical evidence says that it does not get anything from competition and capitalist states have been trying for more than a century, according to their own economists and despite the (false) statements of Keynes. In addition, it turns out that the States (the 194 existing ones) are the main economic subject in the main situation of monopoly and concentration! That is, they themselves have eliminated all internal competition in their countries for their own production. And outside their countries, they tend to monopolize the markets of the rest of the countries with their private companies (economic imperialism). The Global South knows a lot about that Imperialism.
      If every economic subject should and does tend towards concentration, it would be better and more profitable to go directly towards it, right?’ It is already done and it has a well-known name: Socialism. Democratic Socialism.

    2. You have it backwards.

      It is not disposable income that creates wealth, but it is wealth that creates disposable income. Humans first have to produce, then they can start to think about consuming.

  6. Have to admire the persistence of capitalist political-economic ideologies; not only has neo-liberalism survived 2008-2009, that crash has reinvigorated iterations of “Keynesian-ism.”

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