The embarrassing truth about trickle-down

Photo credit:   Nickster 2000

January 27, 2014 // By: Faiza Shaheen

Ed Balls’ announcement that, if elected, the Labour Party would increase the top rate of income tax from 45p to 50p has resulted in angry business lobbies and Conservative ministers claiming that the move is ‘anti-business’. The way they see it, the move would drive away talent and wealth creators and ultimately undermine the recovery.

This is a classic example of trickle-down economics in action. That is, the idea that the rich create economic prosperity that we all gain from. Used to slate virtually any policy that threatens the profits of the mega-rich, trickle-down has a stranglehold on our economic and social policies. It underpins our highly skewed corporate and income tax policies, decisions about public sector spending cuts, weak banking regulation, extortionate executive pay, on-going attacks on workers rights and much more. Worst of all, the powerful have clung to trickle down for so long that people are starting to confuse it with common sense.

Which is why today I want to spill the beans on trickle-down economics.

First, one only needs to look at income growth at the top versus stagnation in median wages to know that wealth has not trickled down. Instead it has amassed at the top. While FTSE 100 CEOs have seen a cumulative 480 per cent pay rise since 1998,  income for the average worker has barely budged. The top 10 per cent are now sitting on more wealth (including financial, property and assets) than the entire bottom half of our population. Perhaps even more concerning is that this wealth has flooded out to tax havens – with billions stored safely away from the UK taxman.

Hoarding of wealth only makes it more likely that prosperity will not trickle down. Nobel-prize winning economics Professor Joseph Stiglitz has discussed the rise of ‘rent-seeking’ – which includes the rich using their wealth to lobby government to ensure policies continue to favour their needs and desires. Furthermore, as the rich get richer, they become increasingly isolated from the rest of us – making them less empathetic and so less supportive of the welfare state.

What about the other promise of trickle-down – that by helping the rich to get richer we will expand jobs and investment and hence boost economic growth?

In reality, the data shows that neither employment nor domestic investment are directly correlated to the top income tax rates. In fact the datasets tend to show oscillation more closely related to the business cycle than to the top tax rate. Some may argue that employment and investment may have been even lower if it had not been for the trickle-down approach – but again the data contradicts this claim. The UK grew more and had a higher employment rate in the period 1960-1979 when we were one of the most equal countries in the developed world.

There is little correlation between lower top rates of income tax and employment growth…

Source: OECD and HMRC

…or between lower top rates of income tax and private investment*

 

Source: OECD, ONS and HMRC

Those that say that, at the very least, everyone has benefited from the innovation spurred by top corporations are referred to the excellent analysis by Mariana Mazzucato. It shows just how important government and public investment has been to the emergence of the technologies that play such an important part of our lives.

Who’s really fuelling our economy?

A final argument made in support  of trickle-down economics is that  spending by the rich buoys up consumer demand. The intuition behind this argument goes something like: the rich can afford to buy luxury goods and generally consume more, they can afford to travel and eat out frequently;  and all of these activities create jobs which  provide incomes for others to spend and so on.

The problem is that consumption patterns show it is the middle class who sustain  demand in the economy. This is why when the recession hit demand fell sharply even while the rich continued to see increases in income and luxury goods continued to sell . President Obama has put this reality succinctly in recent speeches noting that “growing inequality isn’t just morally wrong; it’s bad economics. When middle-class families have less to spend, businesses have fewer customers”. He concludes that "prosperity needs to come from the 'middle out' rather than the top down." 

Time to move on

The trickle-down approach has been bad economics.  Not only has it failed to deliver on its own terms but it has actively damaged the health of our economy, society and political system. It has supported growing inequality which, rather than boosting economic performance,  has deflated it. The UK grew more when we were a more equal country during the post-war, pre-Thatcher era than after. It’s damaging social effects are also mounting. High levels of inequality are increasingly seen as harmful to individual well-being and health, social cohesion and social mobility.

Obama’s attack on trickle-down economics, echoed by Labour Leader Ed Miliband offered hope that our leaders are finally engaging in the possibility of  dethroning this damaging philosophy but the recent response to a potential increase in income tax shows that the theory still festers. We must continue to counter an approach that has created a tide of inequality that lifts up the yachts while leaving the rest of us paddling harder. By pulling the rug out from under trickle-down economics other damaging myths can be exposed, such as the argument for high executive pay.

Higher taxes on the rich – such as Ed Balls’ 50p tax – alongside predistributive policies including free high quality childcare, greater collective bargaining coverage and increased public investment in job-rich sectors would result in a more inclusive type of growth. Delivering an economy which focuses on the majority and not the minority will benefit us all through a more stable economy and society. Business lobbies would do well to remember this.

 

 

* We use private non-residential gross formation as a measure of private investment. This includes non-residential building, other construction, land improvement, transport equipment, plant, machinery and equipment and the intangible assets of industries and producers of private non-profit services to households, less their net sales of similar second-hand and scrapped goods. We calculate this investment volume as a percentage of the UK GDP volume (seasonally adjusted, £s constant prices).

Issues

Inequality, Monetary Policy, Macroeconomics

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