Recently, the day before meeting up with newly elected British Prime Minister Liz Truss at the UN General Assembly in New York City on 21 September 2022, US President Joe Biden tweeted that he was “sick and tired of trickle-down economics”, having opted for “building an economy from the bottom up and middle out”. It is unclear whether he was expressing his disapproval of Ms. Truss’s soon-to-be announced plans for personal and corporate income tax cuts and reversals or merely restating his long-held economic views in the context of aggressive Republican rhetoric in the run up to the American midterm elections.
The use of the term ‘trickle-down’ to describe economic policies that favour the highest earners is commonly attributed to Will Rogers, an American vaudeville performer and actor, who, in his role as satirical political commentator, expounded his views in his syndicated column in the St. Louis Star and Times on 26 November 1932, the caption for which made the point that “Money, Unlike Water, Always Trickles Up.” At the time, he was critiquing the Reconstruction policies of Republican President Hoover, who was about to make way for the interventionist Franklin D. Roosevelt.
Like many seemingly intuitive and superficially attractive theories, the belief that economic growth is driven by tax cuts for big corporations and high-net-worth individuals, and by deregulation of the business environment, does seem to make some sense at first glance. The monies released by lowering direct taxes on corporate and personal income, on capital gains from the sale of certain assets, and on dividends from shares, could be guaranteed to find their way back into the economy. Corporations would then invest in capital equipment and upgrade their infrastructure, encourage technological and other form of innovation, supply more goods and services, and most importantly create new jobs, while wealthier individuals would find incentives to stimulate business growth through investing their wealth, on their own initiative. On the other hand, disproportionately heavy taxation of big business, and of the wealthiest individuals, would both encourage tax evasion and also discourage productive economic activity by reducing incentives to invest, to work, and to take risks, as it would no longer be worth the extra effort.
According to the above viewpoint, an expanded and wealthier workforce, earning higher wages in a growing and productive economy, would feel confident to spend their hard-earned money on goods and services, thereby driving up demand and boosting economic growth, which in turn would cancel out government revenue losses from lowered marginal tax rates (the rate of tax paid on each additional hour of work undertaken). The controversial bell-shaped Laffer curve, by some accounts first sketched on a restaurant napkin by the economist Arthur Laffer in 1974, provides support for such “supply-side economics”, starting with Reaganomics, by apparently demonstrating that beyond a certain optimum tax rate, increases in taxation are inefficient and no longer increase government revenues. Proponents of cutting taxes on earnings also believe that the distortive impact of taxation on earnings can be more than offset by indirect taxes on consumption and property instead.
All of this, however, disregards the all-important behavioural aspects of economic activity and assumes that these beneficiaries of tax cuts are altruistic, forward thinking, and forward looking, and have subsumed short-term profiteering for the greater potential benefits of long-term economic growth. The fact is, not all surplus profits are being pumped back into the system for the greater good, but are instead being invested in the financial markets, sequestered by tax evaders in tax havens and shell companies, laundered in other illegal schemes, protected by legal tax avoidance schemes, or squandered in the pursuit of an insatiable and hedonistic conspicuous consumption culture.
There is already a great deal of information about the effects of tax cuts for economists, politicians, social commentators, and interested members of the general public to dwell upon, with numerous interpretations of their benefits or otherwise. Three recent Republican US Presidents, in particular, can be credited with providing us an opportunity to study the impact of tax cuts on the wider economy. First, there was Reagan’s Tax Reform Act 1986, followed by George W. Bush’s Economic Growth and Tax Reconciliation Act 2001, and, most recently, Donald Trump’s Tax Cuts and Jobs Act 2017, each of which were followed by a spurt in economic growth. This growth was not sustained in the longer term for various reasons. The federal budget deficit was tripled from higher defence spending under Reagan, rising unemployment in the early 2000s required corrective action, and the most recent macroeconomic external shock of COVID pandemic stifled economic growth for a while. It also become clear that income inequality rose in the wake of tax cuts, implying that the wealthiest benefited disproportionately, despite wide-ranging tax cuts across all income brackets.
The British situation is of some interest, with promises of cuts and reversals involving both direct and indirect taxes in the emergency cost of living mini-budget, officially described as a “fiscal event”, to be announced on 23 September 2022. Those with a net income of £150,000 and above per annum, normally subject to a 45 percent additional rate of income tax, will the main beneficiaries of income tax cuts. The 1.25 percentage point rise in National Insurance (from April 2022) will be reversed from 6 November onwards, and the planned Health and Social Care Levy (from April 2023) will be abandoned. The nil-rate stamp duty threshold on property purchases will be raised. Planned increases in corporation tax will not go ahead, while caps on bankers’ bonuses, limiting pay-outs to twice their salaries will be removed, so that high performers can be tempted to relocate to the City of London. At the same time, government revenues will fall further as it funds its two-year Energy Price Guarantee, not by a windfall tax on the profits of oil and gas producers, but instead by the fiscal stimulus of increased government borrowing. In addition, macroeconomic shocks from rising wholesale energy prices and from inflation-busting increases in interest rates complicate the overall picture. The latest experiment is about to begin, just as the UK appears to be going into recession. Its guinea pigs, the British public, will in due course be able to judge for themselves whether the chosen direction of travel best matches up with their expectations and needs, even as economists continue to squabble over the minutiae in the meantime.
Ashis Banerjee