Is trickle-down economics valid?

If a government decides to be generous with tax cuts, the precondition should be the government must have a strong balance sheet to support the gap between the fall in tax collection and the fiscal spending.

THE trickle-down economics method has been used by past policymakers in strengthening a country’s economy.

This is especially favoured in times of economic uncertainty where large corporations and business owners were relied upon to help rejuvenate and spur growth.

Governments dish out favourable tax cuts to the upper income brackets and provide incentives for big companies to entice them to make investments and help with increasing employment opportunities.

The idea is if large corporations and business owners reinvest or expand their business, the wealth from the top can trickle down to the common people on the ground via job creations.

Most notably, former US presidents Ronald Reagan and George W. Bush were strong proponents of this approach. Until today, it is still a guiding economic principle of the Republican Party in the United States.

With the backdrop of today’s inflationary climate and hawkish Federal Reserve (Fed) rate hike direction, I would like to draw attention to “Reagenomics”, which was a term supporters credited to Reagan’s economic policy as they believed it ended the 1980s recession caused by runaway inflation.

Back then, Reagan cut the toptier tax rate from 70% for people earning more than US$108,000 (RM508,410) down to 28% for those earning US$18,500 (RM87,088) or more. He also reduced the corporate tax rate downwards from 46% to 40%.

This was a hallmark achievement of the Reagan administration. However, was it truly Reagan’s trickle-down economic policy that made it all right?

Capital markets upheaval

We must note that the tools in a government’s pocket is not only adjusting tax rates. There is the fiscal policy and there is the monetary policy. Both goes hand in hand and must work in tandem to attain an optimal outcome.

The central banks manage the monetary policy by intervening in financial markets via interest rates, buying and selling of bonds among others, effectively controlling the money supply.

The government itself then manages the economy via policies such as fiscal spending, which includes infrastructure developments, distributing welfare support and the likes.

Subject to the economic situation of the day, the policies will be adjusted accordingly. What is important to note is that tax collection is always the main source of income for a government.

If a government decides to be generous with tax cuts, the precondition should be the government must have a strong balance sheet to support the gap between the fall in tax collection and the fiscal spending.

In this context, we must remember that during the Reagan administration, the US economy was going through a runaway stagflation (high inflation and slow growth). It was Paul Volcker, the Fed chairman then, who took the extreme route of hiking interest rates to as high as 20% to reign in the inflation.

This led to a recession. Thus, the trickle-down economic policy of “Reagenomics” was never truly tested and in essence, it was more of the monetary policy that laid the foundation for the subsequent economic recovery.

History tends to repeat itself. As the United Kingdom was battling with high inflation and staring at an impending recession, the newly appointed Prime Minister Liz Truss was eager to demonstrate her ability to steer the country from its challenges.

Whether it is her, her cabinet ministers or advisers who opted to put forth a “Reagenomics” like policy when formulating the mini budget, it was clear that it was both a premature move.

Cutting taxes for high-income earners and removing tax hikes for corporations was never going to be able to spur consumption or encourage investments. In fact, inflation impacts the rich the least and hits the poor the most.

If anything, a broad-based tax cut for the lower and middle-income segment of society would do more to support the economy.

But the nail in the coffin was when the bond market plunged as investors were spooked by the unfunded fiscal spending proposed by Truss and her team.

Where was the money going to come from? This is a crucial question, especially after the significant quantitative easing embarked by central banks around the world, including the Bank of England, in the past two years to overcome the pandemic.

Quoting Warren Buffet, “Inflation swindles everyone.” She ended up entering the history books as the shortest UK prime minister with a tenure of only 44 days.

Voting pattern affects policies

The idea of a democracy has always been one person one vote. Everyone has a say when it comes to election. It is also the only time where politicians must account for their actions and conduct.

Hence, it is not farfetched to believe that voting pattern of the masses will have a direct impact on the policies by those in power.

I have seen many polls conducted and mostly, economic concerns are on the top of the mind of the people.

With wealth disparity increasing over the years, the top 1% of the population controls 45% of the global wealth, according to the Credit Suisse Global Wealth Report 2022.

A stable society cannot have great inequality otherwise it will lead to instability. History has shown us that the greatest empire collapsed because those in power failed to recognise their roles in being a custodian and steward of the society.

Personally, I do not believe in usurping and undermining the effort of entrepreneurship by penalising those who attain wealth through years of hardwork and sacrifices.

For example, I do not subscribe to the likes of windfall tax. However, I believe that favourable tax incentives should be in place to encourage entrepreneurial, philanthropic and altruistic endeavours.

In addition, to narrow the gap, broadbased policies should be formulated instead.

Prior to the dissolution of the Parliament, the government then tabled Budget 2023, which happens to be the largest on record. There were concerns on the source of revenue for the government’s fiscal spending in the coming year.

The downfall of Truss was due to the lapse in judgement in policymaking decision leading to capital markets upheaval. Another important aspect was her administration tabled a mini budget without a forecast by the UK’S fiscal watchdog, the Office for Budget Responsibility.

Therefore, it is imperative for the new government after the elections to allay concerns on the source of revenue and ensure that populist measures will not take precedence over fiscal responsibility.

Closing the gap

Although the United States and China is currently at a low point of their diplomatic relations, I have observed that there are similarities between the current President Joe Biden administration and President Xi Jinping’s policies.

The former advocates building the country from the middle and the bottom outwards, not from the top down. The latter believes in the common prosperity agenda and with the recent conclusion of the 20th National Congress, reiterate the country’s stand to achieve moderate wealth for all instead of concentrated wealth at the top.

Just like climate change and the green agenda, most policymakers try their best to formulate policies in line with the trend of their times. Governments can do no wrong when they champion to close the gap of income inequality of the people.

While the effects are not immediate, improving the lives of the population and lifting them from poverty will ensure sustainability of a nation’s economy in the long run.