What is ‘trickle-down’ economics?

All our clients reading this will be aware of the fallout from new Chancellor Kwasi Kwarteng’s recent ‘fiscal event,’ delivered on the morning of September 23rd.

The 45p rate was abolished, the planned increase in Corporation Tax quickly followed and National Insurance hikes were reversed.

The right-wing think tanks loved it: Nigel Farage called it ‘the best Conservative Budget since 1986’. Several papers and commentators took the opposite view. The word ‘gamble’ featured in many headlines, often accompanied by ‘reckless’.

The pound fell sharply – and at one point came perilously close to parity with the dollar. The Bank of England was forced to intervene amid liquidity fears from pension funds. The 45p rate of tax was reinstated – as the Chancellor said he’d “listened”.

The measures introduced in the speech were hailed by supporters as a perfect example of ‘trickle-down economics’. It’s a phrase we hear a lot. But what does it really mean? And what are its chances of working?

The theory is simple. Reducing taxes for high earners and the wealthy, and giving tax-breaks and benefits to companies, will ‘trickle-down’ to everyone else as they spend or invest their extra wealth.

Trickle-down economics involves less regulation, and tax cuts specifically favouring businesses and the wealthy.

You may have heard of the ‘Laffer Curve’ – developed by American economist Arthur Laffer. It tracks the relationship between tax rates and tax receipts. Laffer’s idea was that tax cuts could boost growth and tax revenue and was quickly labelled ‘trickle-down’.

And he appeared to be correct. Under President Reagan between 1980 and 1988, the top marginal rate of tax in the US fell from 70% to 28%: between 1981 and 1989 total federal receipts increased from $599bn (£532bn at the current exchange rate) to $991bn (£880bn).

Critics, though, argue that the added benefits the wealth provides do not trickle down – they simply add to growing income inequality. As current President Joe Biden recently said: “I am sick and tired of trickle-down economics. It has never worked.”

“We are building an economy from the bottom up and the middle out,” he added, referring to the recent US stimulus package.

As the old saying has it, ‘you pays your money and you takes your choice’. If you’re on the right of the political divide, you may agree with Winston Churchill, who said:

“I contend that for a nation to try and tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.” If you’re left of centre, then, like Joe Biden, you’ll think that a cut in bankers’ bonuses is the last thing working families need.

There is perhaps one thing we can agree on. The debate about trickle-down economics will continue for as long as we have politicians and economists.