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What is trickle-down economics and how does it affect business and consumers?

·Business Reporter, Yahoo Finance UK
·5-min read
Trickle down economics: British Prime Minister Liz Truss in New York
Liz Truss will hold her first bilateral meeting with Joe Biden while in New York for the UN General Assembly. Photo: Reuters/Toby Melville/Pool

UK prime minister Liz Truss has urged world leaders to follow the UK in introducing far-reaching tax cuts, setting her at odds with her American counterpart.

Truss is known to have supported the idea of “trickle-down economics” during the Conservative leadership contest, arguing it was wrong to view all economic policy through the “lens of redistribution”.

However, her economic policy views have contrasted with other global leaders, with US president Joe Biden tweeting: “I am sick and tired of trickle-down economics. It has never worked. We’re building an economy from the bottom up and middle out.”

The pair will hold their first bilateral meeting while in New York for the UN General Assembly. They are expected to discuss the economy, the energy crisis and the Northern Ireland protocol.

What is trickle-down economics?

Trickle-down economics specifically advocates for a lower tax burden.

The idea is to cut taxes for the rich, entrepreneurs, and for large corporations to encourage growth, which is ultimately believed to then trickle down to benefit smaller businesses and consumers through jobs and investment.

This is through tools such as reduced income tax and capital gains tax breaks.

The theory suggests that entrepreneurs are more likely to start-up new businesses, as well as expand, and companies are more inclined to invest. In addition to this, banks will tend to increase lending if they are paying less in tax.

Read more: UK cuts business energy bills in half to stop firms collapsing

Initially, those that stand to benefit are the rich, but the idea suggests that everyone stands to gain as the economy grows, and well-paid jobs are created for working people.

Truss told the BBC this week: “We do have to take difficult decisions to get our economy right. We have to look at our tax rates. So corporation tax needs to be competitive with other countries so that we can attract that investment.

“Lower taxes lead to economic growth, there is no doubt in my mind about that.”

Ronald Reagan and Margaret Thatcher
Former president Ronald Reagan with the then British prime minister Margaret Thatcher during a tour of the Ronald Reagan presidential library in Simi Valley, California, on 4 February 1991. Thatcher's husband Denis is at right. Regan's tax cuts were described as 'trickle down'. Photo: Kevork Djansezian/AP

Use in history

The term trickle-down originated as a joke by humourist Will Rogers in a column in 1932.

He wrote: “This election was lost four and six years ago, not this year. They [Republicans] didn't start thinking of the old common fellow till just as they started out on the election tour.

"The money was all appropriated for the top in the hopes that it would trickle down to the needy. Mr Hoover was an engineer. He knew that water trickles down. Put it uphill and let it go and it will reach the driest little spot. But he didn't know that money trickled up.

“Give it to the people at the bottom and the people at the top will have it before night, anyhow. But it will at least have passed through the poor fellow's hands. They saved the big banks, but the little ones went up the flue.”

Read more: UK economy slows as demand falls in August

The idea was also popular in the 1980s, with both Ronald Reagan and Margaret Thatcher championing the idea at the time.

Reagan’s use of income tax cuts were described by economists as trickle down, while president Herbert Hoover’s stimulus efforts during the Great Depression were the same.

Similarly, the Tax Cuts and Jobs Act of 2017 cut taxes across all income brackets, but especially favoured the wealthiest in society.

Criticisms

The biggest criticism of the policy is that it benefits the rich and adds to the growing income inequality in the country.

Truss admitted this week that her tax-cutting plans will initially benefit those well-off more than the rest of the UK. However, she then doubled down with a promise to reverse the rise in national insurance that benefits top earners by about £1,800 a year, and the lowest earner by about £7.

Reagan and George Bush both taxed higher earners during their presidency, but inequality still rose. Between 1979 and 2005 the incomes of the Top 1% of earners tripled while those of the bottom 20% rose by just 6%

Meanwhile in December 2020, a London School of Economics report by David Hope and Julian Limberg examined five decades of tax cuts in 18 wealthy nations. It found they consistently benefited the wealthy but had no meaningful effect on unemployment or economic growth.

Read more: What can we expect from Kwasi Kwarteng's mini-Budget?

It comes as Liz Truss and chancellor Kwasi Kwarteng are finalising the details of Friday’s mini-Budget.

They are expected to unveil a package of tax cuts, as well as a reversal of the National Insurance hike, and possibly a reduction in stamp duty.

Truss recently added that she was prepared to be unpopular and make tough choices for the UK, including removing the cap on bankers’ bonuses.

“If that means taking difficult decisions which are going to help Britain become more competitive, help Britain become more attractive, help more investment flow into our country, yes, I’m absolutely prepared to make those decisions”, she said.

However, Jonathan Reynolds, shadow business secretary, said Joe Biden was right to say trickle-down economics does not work, and hit out on Truss looking to lift the cap on bankers' bonuses and cut corporation tax.

Watch: Labour: Biden right and Truss wrong over economic plan