More evidence against the ‘trickle down’ orthodoxy in macroeconomics

On December 10, 2014, I wrote this blog post – Trickle down economics – the evidence is damning. The discussion was about how inequality undermines growth and that redistribution of national income towards higher income groups does not stimulate income growth for lower income groups. It provided evidence that destroys the basic tenets of mainstream economics and supports a wider social and economic involvement of government in the provision of public services and infrastructure, particularly to low income groups. The ‘trickle down’ fiction was propagated in the late 1970s and early 1980s by the likes of Margaret Thatcher and Ronald Reagan and dovetailed with the emerging dominance of supply-side thinking. Behind ‘trickle-down’ was a nasty neo-liberal plot to undermine state activity and rewind the gains made by the workers under the welfare states and unionism over the course of the C20th. Now a new report from researchers at the London School of Economics – The Economic Consequences of Major Tax Cuts for the Rich – repeats the evidence, and, perhaps because we are further down the road in realising how deficient mainstream macroeconomics is, new evidence of something that we have known since the ideas first came out of the sewers, might push the paradigm shift a little further.

The ‘trickle down’ idea was the opposite of the previous consensus in macroeconomics that demand (spending) had to be managed to ensure economies maintained full employment and income growth.

That, of course, required governments to play a major role to counter (stabilise) fluctuations in non-government spending, which were characteristic of capitalist monetary systems.

It was understood that market systems were prone to crises where economic activity could become stuck at levels that realised high levels of unemployment and that no intrinsic dynamics existed to disturb that malaise.

Marx knew that in the C19th when he attacked the ideas of – Jean-Baptiste Say.

Say is known for – Say’s Law – which effectively denied that there could be mass unemployment arising from a failure of spending to match the level required to support production commensurate with full employment because “supply creates its own demand”.

According to this view, even if consumers stop spending and increase saving, investment spending will rise (using the increased saving) to fill the gap.

I discussed Marx’s insights into this problem in this blog post – We need to read Karl Marx (August 30, 2011).

Keynes took up the debate during the Great Depression in his attacks on the Classical thinking.

I dealt with that debate in some detail:

• Keynes and the Classics – Part 1 – (December 28, 2012) explains how the Classical system conceived of labour supply and demand and how these come together to define the equilibrium level of the real wage and employment.
• Keynes and the Classics – Part 2 – (January 3, 2013) explains how the labour market determines the level of employment and real wage, which in turn, via the production function set the real level of output.
• Keynes and the Classics – Part 3 – (January 4, 2013) tied the previous conceptual development into the denial that there could be aggregate demand failures (Say’s Law), introduced the loanable funds market and discussed the pre-Keynesian critique (Marx) of the Classical full employment model.
• Keynes and the Classics – Part 4 – (January 11, 2013) which began Keynes’ critique of Classical employment theory.
• Keynes and the Classics – Part 5

(January 18, 2013).

So when the Keynesian consensus broke down in the early 1970s, the ideas that that been thoroughly demonstrated to be false decades earlier returned to mainstream status and were taught in university programs throughout the world as if they were knowledge.

But, in reality, ‘trickle down’ was just a fancy short-hand term to provide some sense of authority to the resurrection of these defunct ideas, that were used to justify the hollowing out of the state and the redirection of government support away from public infrastructure, public services and employment, and transfers for lower income welfare towards higher income groups.

There was never any ‘knowledge’ supporting the idea, which is the case for the majority of mainstream ideas.

They are housed as if they are science but the reality is that they are nothing more than religion with a strong ideological zeal supporting a power play by elites who sought to subvert democratic choices that had constructed welfare states and full employment.

By undermining the material gains made in the Post World War 2 period by ordinary workers and their families as a result of strong government involvement in counterstabilising the economic cycle and redistributing national income under equity guidelines, the top-end-of-town could extract and increasing share of national income.

Witness Australia – in the September-quarter 1975, the share of wages in national income was 62.5 per cent. It was still at 61.4 in the December-quarter 1983. By the September-quarter 2020, the wage share had fallen to 49 per cent.

Latest evidence

The question is how many times do we have to have research papers finding the same thing before we refuse to accept decisions by politicians who introduce tax cuts for the rich under the guise of stimulating activity and providing jobs for all?

The latest evidence from the LSE study (by David Hope and Julian Limberg) just reinforces what we have known for decades.

They study data for 18 OECD countries over five decades and seek:

… to estimate the causal effect of major tax cuts for the rich on income inequality, economic growth, and unemployment.

In other words, to examine the links that ‘trickle down’ would rely on.

I won’t go into the technical aspects of the paper suffice to say they:

1. “use a newly constructed, comprehensive measure of taxes on the rich to identify years in which major tax cuts occurred across a wide range of advanced economies”.

2. “we move beyond correlational evidence on the economic effects of taxing the rich by applying a novel matching method that allows for the estimation of causal effects from time-series cross-sectional data.”

The matching technique uses – Mahalanobis distance – which is one of those interesting ideas in distribution theory and PCA that I learned about in my studies in mathematical statistics.

The research documents the “substantially declining taxes on the rich in the last decades” across the OECD.

The OECD, as an organisation, is, of course, culpable here, which is discussed in the blog post I cited at the outset.

For years, the multilateral organisations (IMF, OECD, World Bank) advocated cutting taxes on high income recipients (I don’t use the word ‘earners’ in this context) on the pretext that they would stimulate spending and improve job opportunities for all.

They can reject those narratives now as they try to reinvent themselves, but they cannot deny they perpetuated them within the policy discourse at critical times, which have led to the mess the world is in now (in addition to the pandemic).

The main results of the study include:

1. “major tax cuts for the rich increase the top 1% share of pre-tax national income in the years following the reform … The magnitude of the effect is sizeable; on average, each major reform leads to a rise in top 1% share of pre-tax national income of 0.8 percentage points.”

2. “The results also show that economic performance, as measured by real GDP per capita and the unemployment rate, is not significantly affected by major tax cuts for the rich. The estimated effects for these variables are statistically indistinguishable from zero, and this finding holds in both the short and medium run.”

3. “our analysis finds strong evidence that cutting taxes on the rich increases income inequality but has no effect on growth or unemployment.”

4. “tax cuts for the rich are associated with rising top income shares.”

5. “Our findings on the effects of growth and unemployment provide evidence against supply- side theories that suggest lower taxes on the rich will induce labour supply responses from high-income individuals (more hours of work, more effort etc.) that boost economic activity …”

6. “income tax holidays and windfall gains do not lead individuals to significantly alter the amount they work …”

7. “lower taxes on the rich encourage high earners to bargain more forcefully to increase their own compensation, at the direct expense of those lower down the income distribution.”

Framing problem

The problem with the paper is the way their results are framed.

In the – Press Release – one of the two authors of the paper says:

Our results might be welcome news for governments as they seek to repair the public finances after the COVID-19 crisis, as they imply that they should not be unduly concerned about the economic consequences of higher taxes on the rich.

This was never the concern.

It was always about the hold that high-income recipients have on the political process through a variety of mechanisms – political party funding, lobbying, revolving door arrangements, golf club memberships, etc

‘Trickle down’ was always a con.

The task is to break the hold that they have on our elected representatives.

Taxing the rich should never be a progressive catch-cry if the intention is to get their money to be used elsewhere.

That is just neoliberal framing and buys into the fictions created by mainstream economists that tax revenue is required for governments to spend on progressive causes.

Taxing the rich should always be framed at breaking that hold on the political process.

We don’t governments to have their money. We just want them to have less purchasing power which means they have less political power.

The final sentence in the LSE paper is:

… it would also be important to understand more about the extent to which individuals’ attitudes to taxing the rich are influenced (or not) by the provision of new information about its economic consequences.

Well, those attitudes are influenced by the way in which the evidence is framed and presented.

There have been many studies that reject the ‘trickle down’ but they enter the public debate, where even progressives promote the false views about government financial capacity.

That is one of the important reasons why the mainstream paradigm maintains its hold on the policy debate despite it being without any empirical foundation.

Conclusion

Another nail in the mainstream coffin, which is still to contain the corpse.

There is no question that capitalism on life support now. The negative consequences of the pandemic will endure for years even if (and when) we get the health threat under control.

There is no sense that the ‘market’ can deal with any of this. We should put that narrative to rest forever.

A strong nation requires a strong government involvement in areas that are essential to our well-being.

That requires an orthogonal shift in our thinking about fiscal policy – its purposes, its consequences, its constraints.

We are moving towards that shift but there are powerful forces trying to resist it and/or shape it in their own favour.

That includes all the mainstream economists who are now trying to claim they are leading the shift when just a few years ago they were contributing to the fictions.

So results like those presented in the LSE paper are welcome but without a major shift in our thinking the results will just go into the academic ether and nothing will come from them.

That is enough for today!

(c) Copyright 2020 William Mitchell. All Rights Reserved.