On October 20th 2022, after just 44 days in office, British Prime Minister Liz Truss resigned.
I am resigning as leader of the Conservative Party.
Her brief premiership, the shortest in U.K. history, will be remembered for being mired
by fiscal calamity, political infighting and market meltdown.
But also, her dogged efforts to revive a controversial economic idea.
That theory?
Trickle-down economics, a term most closely associated with Ronald Reagan and Margaret Thatcher.
Truss’ experiment was maybe a sort of last gasp of trickle-down, the disastrous results
may have been the death knell of that philosophy.
Stock markets were roiled, and the British pound plunged against the dollar, after the
new U.K. government unveiled a “mini-budget” of tax cuts seen to disproportionately benefit
the wealthy, even as the country faces a worsening cost-of-living crisis.
The move prompted critique from financial institutions and political ire from across the Atlantic.
Even the Bank of England was forced to intervene.
I think trickle-down is a bit of a boogey term for people who dislike free market ideas.
So just what is ‘trickle-down’ economics and why did it cause the U.K.’s economic strategy to implode?
‘Trickle-down’ economics is the theory that deregulation and tax cuts at
the top levels of society, namely for businesses and the wealthy, will eventually trickle down
to benefit the population at large.
Coined as a phrase by political opponents critical of top-level tax cuts, the term trickle-down
falls within, but differs from, wider “supply-side" theory, which focuses on increasing the supply of labor
and advocates lowering taxes for all.
People who believe in the kind of trickle-down about cutting taxes for the wealthy, for the entrepreneurs,
their supply-side story is that there will be such a strong response
of new people founding firms, more Bill Gates, more Elon Musks, because there’s more of
an incentive to come up with the ideas if you can get big rewards for them.
The idea is closely linked to the Laffer curve, an economic model popularized in the 1970s
by U.S. economist Arthur Laffer, which showed the relationship between tax rates and tax revenue.
According to the model, when taxes pass a certain level, they become counterproductive
for increasing tax revenue.
Crucially, that tipping point tended to come when taxes were prohibitively high, over 50%.
He argued that if you cut taxes, for example for the very wealthy, they pay for themselves.
The idea is that if you cut taxes for the wealthy, they work so hard, they generate
so much more growth and tax revenue, you actually end up with more tax.
Trickle-down economics truly rose to fame in the 1980s under U.S. President Ronald Reagan
and U.K. Prime Minister Margaret Thatcher, who were both strong proponents of tax cuts as a way
of spurring overall prosperity.
Now some critics complain your tax cut is too big, that it costs government too much.
Well, this may be a shock to them, but that money isn’t the government’s to begin with.
More recently, Donald Trump campaigned on “the largest tax cuts in the history
of the United States of America."
Meanwhile, in France, President Emmanuel Macron abolished the country’s wealth tax in 2018
and joined the likes of Ireland in reducing corporation tax and deregulating industry
in the name of growth.
But trickle-down economics has come up against harsh criticism over the years, with some
political scientists dubbing it a “zombie” theory; an idea which has endured in public discourse
despite long being disproven.
In a 2015 paper, the International Monetary Fund noted that “a rising income share of the top 20 percent
results in lower growth — that is, when the rich get richer, benefits do not trickle down.”
If you look, say, over the last 30, 40 years, a lot of countries that have reduced the tax
rate on the most wealthy, the U.S., in particular, that hasn’t led to some boom of growth.
The top 1% have got a lot, lot bigger shares of the pie.
In the U.S. between 1979 and 2007, the net income of the top 1% of earners nearly tripled
while those in the bottom 20% rose by just 16%.
The findings have been mirrored over the years in multiple reports.
A 2020 study of five decades of tax cuts, spanning 18 wealthy countries, found that the effect
of “major tax cuts for the rich on real GDP per capita is close to zero and statistically insignificant.”
Still, in 2022, Liz Truss campaigned and came to power on promises of tax cuts, particularly
for the top end of the economic spectrum.
The U.K. government, for its part, has resisted the term “trickle-down ecconomics,”
instead referring to its ‘Economic Growth Plan’ as a series of supply-side reforms.
Matthew Lesh is head of public policy at London’s Institute of Economic Affairs,
a free market, right-leaning financial think tank that works closely with the U.K.'s Conservative Party.
I reject the characterization of trickle-down economics in that I don’t think that’s
a philosophy that anyone is doing or supports.
I think that’s a bit of a slur.
What I would say is that the kind of policies the government’s talking about, in terms
of boosting productivity, increasing economic growth, expanding the size of the pie and
making it bigger so everyone can get a bigger piece, that kind of a policy agenda is very
sensible and reasonable and something that I think can increase prosperity.
The challenge is making that politically palatable.
That challenge, as it turned out, was entirely underestimated.
In a September 2022 “mini-budget,” the U.K.’s then Finance Minister Kwasi Kwarteng
announced £45 billion worth of corporate and income tax cuts, including removing the cap
on banker bonuses, financial markets balked, and sterling was sent into freefall.
Britain’s central bank, the Bank of England, was forced to step in with an emergency bond-buying operation
to restore credibility to chaotic markets.
Meanwhile, the unfunded tax cuts drew global criticism.
In a rare statement, the International Monetary Fund said the plans would “likely increase inequality”
and urged the government to “reevaluate the tax measures,
especially those that benefit high income earners.”
Days later, the Treasury was forced to U-turn on one of its most controversial policies
of scrapping the top 45% rate of income tax for those earning over £150,000.
It was the wrong thing to do.
Within weeks, Kwarteng was given the boot and, with it, most of his economic policies
were thrown out by successor Jeremy Hunt.
There are going to be difficult decisions in terms of public spending cuts, in terms
of increases of taxation.
The government’s strategy was considered particularly ill-timed as the country faces
its worst cost-of-living crisis in a generation, amid soaring inflation and higher energy costs.
As of September 2022, U.K. inflation hit a 40-year-high of 10.1%, after dipping slightly in August.
The Bank of England, alongside central banks across the globe, has been aggressively raising
interest rates in a bid to cool the economy and bring down prices.
Now, with inflation going up and interest rates going up, having big, unfunded tax cuts
is going to throw fuel on the fire.
It’s like Liz Truss and Kwasi Kwarteng have got their foot on the fiscal accelerator and
the Bank of England’s got its foot down on the breaks.
That’s not a good way to drive a car.
Of course, tax cuts are just one approach to economic policy.
So what could be a better alternative which improves living standards and prosperity across the board?
Professor Eric Beinhocker, founder at the Institute for New Economic Thinking,
an Oxford-based public policy research center, thinks he has a solution:
something he calls “middle-out” economics.
What does actually increase long-term growth are investments in the broad middle of the economy.
In middle-income households, their education, skills, the infrastructure that they use and
doing things that can increase their productivity and wages over time.
It’s middle-income households that do the bulk of the spending in the economy,
and that spending then creates real incentives for businesses to invest in new products and services
and innovation and grow.
So you get this virtuous circle between demand and innovation and growth.
The theory has some high-level stakeholders, including U.S. President Joe Biden, who made
the policy a central tenet of his March 2022 State of the Union address.
Build the economy from the bottom up and the middle out, not from the top down.
President Biden, who came from a working-class background himself and spent much of his career
with working families and very committed to labor issues and so on, I think he intuitively
kind of got the logic.
And so his administration has actually been quite a dramatic shift in direction.
But as for the U.K., it might be some time yet before it recovers from its economic experiment.
For the average voter, they want to know if their life is going to get better over time.
And so being able to show how these things go together in a positive way, that a more
fair and inclusive society will also be longer term more productive and growing society,
I think, has the benefit of being economically true and a very positive political narrative.
The way, ultimately, to deal with this, I think, is being able to get that economic
growth in the medium to long-term, which is through those supply-side reforms.
If you grow the economy, it means you can all have higher incomes, it means it’ll
be much easier to pay down the government debt as well as fund public services, and
that’s what’s been lacking in the U.K. for the last decade.
So I think the way to square the circle in the medium to long term is through that economic growth.
In the short to medium term, I think it’s very, very difficult, both politically and economically.