Decoupling trickle-down economics

In the quest for an enduringly effective economic model in societies, one which unleashes wealth creation, economic growth, positive Gross Domestic Product (GDP), low unemployment, heightened aggregate demand and robust multiplier effects, economists have, over time, proffered various theories, all of which have their relative merits and demerits.

These include, but are by no means limited to: i.) Classical economics; ii.) Keynesian economics; iii.) Monetary economics; iv.) Supply and demand economics; v.) New growth theory; and vi.) Trickle-down economics. Advanced by the early political economists like Adam Smith, David Ricardo, John Stuart Mills et al, classical economics, propounds that free market (capitalist) economies are self-regulating systems governed by the rules of production, contractual exchange and eternal certainties of buying and selling. Smith, its original 18th Century proponent, conceptualised the invisible hand as a figurative rationale for free markets in that, individuals, by acting in their own self-interests, create social benefits and public good.

Keynesian (or demand side) economics, advocates increased government spending on infrastructure, education, expansionary fiscal policy to stimulate demand and therefore economic growth. For example, creating a lower earnings limit such that those with an income of USD 1 to USD 60,000 can benefit from a 15% tax reduction; the commissioning of public housing schemes which must employ over 50,000 full time employees nationwide; subsidising medical school education in the expectation that graduates will remain in the country, pay their taxes and spend on local products and services – boosting domestic growth.

Monetary economic theory posits that governments can achieve economic growth and stability by controlling the supply of money within a given economy. Monetary economic theory advances the view that money supply when multiplied by its velocity (the rate an economy exchanges money annually) yields its nominal expenditure (one converted to a common currency at exchange rates). In that sense, the money supply is a key factor of employment, inflation and production rates; ergo, economic growth.

The importance of monetarism is manifested in the seminal influence of Central Banks in developing economies’ monetary policies relative to the setting of interest rates, government bonds, banks’ capital reserve ratios, foreign exchange rates, capital importation and exportation regimes. More widely, monetary economic theory affirms, in part, the rationale for the existence of organisations like the International Monetary Fund (IMF) with a raison d’etre for global economic cooperation; the independent and quasi-independent Monetary Policy Committees of the Bank of England, the Central Bank of Nigeria, the Federal Reserve Bank etc with overarching aims of safeguarding financial stability, setting interest rates, quantitative easing and related financial and monetary policies.

Regarding the dynamics of price determination, supply and demand economics is the reigning principle. Simply, as the demand for a product or service increases, and the supply remains constant or decreases, in all probability, the price will increase. Conversely, where supply is constant or increases and demand shrinks, so will the price ceteris paribus, other things being equal. The laws of supply and demand govern genuinely free market economies around the world.

The new growth theory reinforces the fact that as society evolves so do economic ideologies adaptively, because of heightened innovation, enterprise, productivity and economic growth. The foundational assumption of this model is that competition, inherent in all market economies can, and often does, reduce profitability. Therefore, in order to be profitable, organisations have to consistently innovate, operate efficiently, be technologically savvy and afford consumers choice thereby enhancing economic growth and, in the process, catalysing positive externalities.

With those foundations established, attention turns to trickle-down economics. Implicit in its name, trickle-down economic theory is one where economic policies are designed, with intentionality, to be most advantageous to those in the upper income echelons and corporations. The underlying philosophy is that if economic policies benefit corporations and wealthy folks, they in turn, through enterprise, innovation, operational efficiencies, investment, the facilitation and deployment of capital, technology, financial instruments, would catalyse employment across other rungs of the economic pyramid. That, in turn, would increase net productivity, optimise positive multiplier effects, and stimulate fiscal revenue to the state thus boosting economic growth.

Although there is no singular policy, which exclusively characterises trickle-down economics, nevertheless, any one instrument disproportionately skewed in favour of top earners and corporations is perceived as such by rational minds. These include cuts in income tax, capital gains exemptions, reductions in corporation tax, cuts to stamp duties, deregulation, removing caps on salaries and share bonuses. It is in this sense that trickle-down economics is often viewed as a supply-side economic theory because it posits that economic growth can be catalysed via tax cuts, deregulation and free trade. And, that consumers will benefit from competitive prices for goods and services, which will boost employment.

Typical examples of the practical application of supply-side economic theories include investments in human capital, education, healthcare, and facilitating the transfer of technologies and business processes, to improve productivity (output per worker/per productive time). It entails international free trade via containerisation; tax reduction, to provide incentives to work, invest and take risks. It also envisages, within relativities, the elimination or lowering tariffs; investments in new capital equipment, research and development (R&D), to further improve productivity and the reduction bureaucracy to stimulate business creation and growth.

That said, is trickle-down economics a proven model? How sustainable, if at all, is it? Does it offer the claimed benefits? Upon what foundation is the hypothesis that corporations and top earners act altruistically?
As with every model, trickle down economic theory has its proponents advancing strong arguments, and its opponents with equally robust counter-arguments. Proponents point to the economic policies of the 40th President of the United States of America, Ronald Reagan (1981-1989); which were christened “Reaganomics.”

For example, the Economic Recovery Tax Act 1981, inter alia, cut the highest personal income tax rate from 70% to 50% and the lowest from 14% to 11%. It also decreased the highest capital gains tax from 28% to 20%. Likewise, the Tax Reform Act 1986, cut the personal income tax rate from 50% to 38.5%. Similarly, the Economic Growth and Tax Relief Reconciliation Act of 2001 signed into law by the 43rd President of the United States, George W. Bush, lowered, inter alia, federal income tax rates, reducing the top tax rate from 39.6 per cent to 35 per cent. However, tax reductions, in of themselves, do not establish a correlation with economic growth.

Conversely, opponents of trickledown economics have queried its justification because there is no definitive proof that some top earners and corporations inexorably predicate their economic decisions on altruism nor morality of any kind. If they did, why, do top earners actively exploit legitimate tax avoidance schemes to place their investments in opaque offshore blind trusts in tax havens? The American economist, Thomas Sowell, in his 2012 coup de maître, “Trickle Down Theory” and “Tax Cuts for the Rich” contends:

“Let’s do something completely unexpected: Let’s stop and think. Why would anyone advocate that we “give” something to A in hope 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…”

An International Monetary Fund report, Causes and Consequences of Income Inequality: A Global Perspective (2015), observed that where the income distribution of the top 20 per cent (the rich) increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down. Conversely, an increase in the income share of the bottom 20 percent (the poor) is associated with higher GDP growth.

Affirming that proposition, the authors David Hope and Julian Limberg, in their seminal article: ‘The Economic Consequences of Major Tax Cuts for the Rich” published in the Socio-Economic Review, Volume 20, Issue 2, April 2022, critically analysed the tax policies on top earners in 18 countries of the Organisation for Economic Co-operation (OECD), in the 50 years between 1965 and 2015. And, they found no evidence that tax cuts for wealthy people trickle down to catalyse the wider economy. The research findings also established that tax cuts for top earners lead to higher income inequality.

Now then, economic models and hybrids thereof, do not exist in isolation. They subsist within a socio-economic and socio-political context in any given society. More recently, the economic policies of the former British Prime Minister, Liz Truss, widely characterised as trickle-down economics cost her not only the premiership (September 6, 2022 –October 25, 2022), but immediately prior to that, truncated the nascent career of her Anglo-Ghanaian, Old Etonian, Chancellor of the exchequer, Kwesi Kwarteng.

The latter announced a significant policy shift in an abridged budget announcement of September 23, 2022 proposing, inter alia, the abolition of the 45% top rate income tax; cancelling corporation tax and increases in national insurance contributions; plus, cutting stamp duties – all to be funded by borrowing. The announcement spooked the financial markets and triggered a rapid depreciation of the pound against the dollar, increased borrowing costs and prompted the Bank of England to buy back government bonds. This was roundly criticised by the IMF, the British public and politicians of all hues.

To conclude, there is no perfect economic model neither is there any mutual exclusivity amongst the models examined in this analysis. In the main, nation states utilise a variety of economic models based on their unique socio-economic and socio-political circumstances. In a practical sense, the new growth theory (supra) appears to be the prevailing economic orthodoxy in an ever increasingly volatile, uncertain, complex and ambiguous global order. That having being said, the allure of trickle-down economics is just that. There does not appear to be a compelling rationale for so-called trickle-down economics because the evidence base for its successful application does not exist. But, has it ever?
Ojumu is Principal Partner at Balliol Myers LP, a firm of legal practitioners in Lagos, Nigeria.