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.


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.

This Post Has 11 Comments

  1. It’s always only ever been “trickle up.”

    The reason to tax the rich has nothing to do with funding government programs and everything to do with preventing the damage that plutocracy does to democracy.

  2. The more I read about financial markets, the more it seems like the question of “what is money” is a very simple but very complex question.

    One interesting example is owning collateral – anyone who has this has an indirect “licence to print money” through the ability to borrow against this collateral. So this means collateral is somewhat similar to money.

    I say this because things that Bill mentions as debunking standard theories such as “quantity theory of money” might actually be debunking the definition of “M” in the MV=PQ formula. Seems like the “derivatives” and “repo/eurodollar” markets that exists hidden from view of standard measures of money supply.

    One interesting chart I’ve seen is how the derivatives and repo markets stopped growing after the gfc in 2008 – it looks to have “moved” over to increased govt debt instead.

  3. It is almost as if the democratic system isn’t mature enough to deal with this obviously false bullshit. It is as if the Wild West, where those with the biggest ‘guns’ won the argument without needing an argument, were alive and well in the 21st century. And, as in the Wild West, prospering. Absolutely dispiriting.

  4. “So this means collateral is somewhat similar to money.”

    Collateral is the money. Banks don’t lend money. Banks buy charges over collateral and offer you various ways of buying that charge back. Even an ‘unsecured’ loan is just a floating charge over your assets – as the bailiffs will explain to you at length when they turn up to collect an unpaid debt.

    Lending is spending. Collateral is what makes you ‘creditworthy’ and banks advance their liquidity to you based largely upon that. When the banks can find nobody creditworthy prepared to pay the current price of money (ie take on the contract to buy the charge back), then bank advances stop and we are at maximum liquidity.

    Collateral exists because somebody used money in the past to create it.

    Only government can create high quality collateral at will, which the central bank in then ordered to discount into its own liabilities. Hence why when you consolidate those two together the money appears to come out of nowhere.

  5. Crystal clear and succinct analysis, again offered to us by Bill, painting the big picture in its most fundamental details. Not being an economist, I tend to get lost in the number crunching Bill also excels at, but the general drift of MMT, what I like to call its axioms, are deeply planted in my mind and in my heart as well, in light of the agency these axioms reveal to meet desperate human and environmental needs. I stumbled across something last night which I intend to use in MMT outreach to those not inclined to dive deeply into theories, economic or otherwise. If I put a link here Bill will have to check it out, as he should, and this post will be delayed. So let me try to slide by via a suggestion that fellow blog readers who desire to spread the MMT gospel, and are looking for appropriate vehicles, do an internet search for “Jimmy Dore Steve Grumbine” and check out the half-hour video of 12/13/20. You might find something worthwhile to share with friends and acquaintances who, while not intellectuals, still need to know the fundamentals of MMT, especially at this time forced upon us when post-Covid resets of the neoliberal world order are being talked about even in mainstream circles.

  6. It will be interesting to see, how, in the UK the Tories square the circle of having to spend whilst preserving the rentier extraction.

    I suspect the plan will be:
    1. Keep the housing bubble going (they’re doing that already).
    2. Funnel money to certain areas but make sure it goes into corporate hands.
    3. Keep the working class split between house own/renter and social housing and at war with each other.
    4. Keep large numbers of people in debt so the banks keep on renting the currency out to supplement wages.
    5. Use the ‘we’ve maxed out the credit card’ meme so that they don’t spend on social care and people are pushed by stealth into private health insurance (already happening).

  7. The main collateral is land – always has been. It’s a real resource which cannot be manufactured – fixed supply. It is in economic terms ‘the environment’: everything which is not human (labour), nor created by humans (capital).

  8. Hi Neil.

    I think you are basically describing the repo market – which is essentially the same thing as collaterised borrowing.

    But…it gets trickier than what you suggest, because the collateral itself is lent just like money (eg rehypothecation). Eg US treasuries get lent….essentially creating additional US treasuries just like lending money creates additional money.
    Also your point about “collateral is money that was already spent” is not exactly true, unless you also recognise that the “interest rate” on that “collateral money” is equivalent to capital growth of the asset.
    This means the “interest rate on money” is not really in control of the central bank, because they don’t participate in these “money like” asset markets.

    Larry, the chart comes from a Jeff Snider blog post on “eurodollar university.”

    I quite like George Gammon’s video explaining the idea.

  9. @’vote for pedro’ I think you are obscuring things. Keynes was correct in his day, and the facts have not changed, money is as the chartalists (State money) defined it: that which is accepted as redemption for a tax payment, fee, fine or levy. This is distinct form the State’s unit of account, which is also called “money” sometimes. Collateral (land, stocks, bonds, other assets) in general is not accepted in most countries I know of, for a tax payment, so is not money. But such things have prices denominated in the money unit of account. That is pretty clear. So please do not confuse the issue.

    For stock-flow analysis some of these forms of collateral are counted as “money” and that’s where you get the M0, M1, M2 definitions, which are also quite clear. If the UK government accepted jugs of beer in redemption for a tax payment, jugs of beer would be money, and would count in your MV=PQ formula, which is just a tautology following from definitions. (Which is not to say it is physically easy to tally up ‘M’ accurately at any point in time, but in principle it could be done to a small uncertainty.) The complications arise when idiots think they can link M to P via erroneous causations.

    All of what I just wrote has nothing to do with bogus popular misconceptions of what money is. Tax receipts are indicative of money income for a non-issuer, but not for a currency issuer for instance. Rentier capitalists are not “wealth creators,” for another instance, although they are centres of money accumulation.

  10. I find it interesting that “fiscal conservatives” become very concerned about their precious “deficit” and the “evil” government spending they suppose is the cause of it… leading on to their inevitable call for cutbacks on welfare spending to get a “surplus”… while simultaneously asking for tax cuts for the rich which apparently have absolutely NO effect on their previously precious “surplus”, “deficit” or whatever.
    Why does “upward moving govt money” NEVER cause the problems that “downward moving money” does? Is it because these “movers and shakers” of media and govt are on the “receipt” side of the govt expenditure and that makes it okay?
    I have never seen an attempt to explain why “the deficit” must always be arrived at by slogging the poor but quite okay when awarding largesse to the rich.
    In fact, the very subject seems to be similar to kryptonite to Superman, especially when the same government expenditure, UP or DOWN, is talked about, discussed, debated… AT THE SAME TIME! It seems to make it… awkward… for them to explain.
    As Julius Sumner Miller would have said, “Why is it so?”

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