Liz Truss favours trickle down economics but results can be trickle up
Trickle down economics was highly fashionable on the political right in the 1980s, when both Ronald Reagan in the US and Margaret Thatcher championed the idea. It resurfaced in America under both George W Bush and Donald Trump, and it is now undergoing a revival in Britain under the new prime minister, Liz Truss.
The theory of trickle down economics is simple. Governments should cut taxes for the better off and for corporations because that is the key to securing faster growth. Entrepreneurs are more likely to start and expand businesses, companies are more inclined to invest and banks will tend to increase lending if they are paying less in tax.
Initially, the beneficiaries are the rich, but gradually everyone gains because as the economy gets bigger well-paid jobs are created for working people. Governments should stop focusing on how the economic pie is distributed and focus on growing the pie instead.
Supporters of trickle down often cite the work of the US economist Arthur Laffer as proof that the theory works. Laffer said tax cuts for the wealthy had a powerful multiplier effect and any revenues lost by governments from reducing tax rates would be more than compensated for by the fruits of higher growth.
Truss is using this argument to justify the £30bn of tax cuts to be announced in Kwasi Kwarteng’s mini budget on Friday, even though Laffer was clear his theory worked best when personal tax rates were prohibitively high, by which he meant between 50% and 100%. At rates below 50%, Laffer found cutting taxes led to bigger rather than smaller budget deficits.
In practice, trickle down did not go according to plan. Reagan and Bush slashed tax on higher earners but inequality soared: between 1979 and 2005 the incomes of the
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