31 July 2015

By David Whyte, Professor of socio-legal studies, University of Liverpool.

If there is one thing that business organisations are particular good at, it is deceiving us into thinking that they are indispensible to a healthy and developed society. But the social contributions that businesses make are always surrounded by propaganda claims and myths that are swallowed too easily by politicians and repeated ad nauseum in the press.

If there is one thing that business organisations are particular good at, it is deceiving us into thinking that they are indispensible to a healthy and developed society. But the social contributions that businesses make are always surrounded by propaganda claims and myths that are swallowed too easily by politicians and repeated ad nauseum in the press.

Perhaps most prominent amongst those myths is the ‘trickle down effect’. The basic claim behind the ‘trickle down’ effect is that lowering tax rates for the wealthy, and for business leads to economic prosperity for all. It is a myth that has shaped UK government policy for at least thirty years, despite there being absolutely no evidence to support the idea that making the rich richer also makes the poor richer.

The ideas behind trickle down are commonly associated with ‘supply side economics’: a theory that sets out how economic benefits for all can be most effectively created by making it easier for businesses to produce (or supply) goods and services.

In fact, the term ‘trickle down’ began as a joke that was invented in the midst of the Great Depression by US vaudeville star Will Rogers. Rogers ironically pointed out in his stage show that “money was appropriated for the top in hope that it would trickle down to the needy.”

“Horse-and-sparrow theory”, an early version of ‘trickle down’ appeared in late 19th century. The idea that was openly promoted by the US government at the time was that “If you feed the horse enough oats, some will pass through to the road for the sparrows.” The US economist and diplomat John Kenneth Galbraith has pointed out that policies based upon this idea caused economic havoc not prosperity, and ultimately caused the US stock market crash of 1896.

Long-term data from the US shows a clear pattern. The period in which taxes on the rich and on businesses were generally increased (the post-war boom) was a period in which the wealth of the poorest 40% increased in real terms. The period in which taxes on the rich and on business were reduced (from the Reagan government in 1980 to the present) was a period in which the wealth of the poorest 40% decreased in real terms.

Although the idea may have lost all credibility in economics, ‘trickle down’ theory is still used widely in politics. Successive UK governments have used various ‘trickle down’ justification to reduce the rate of corporation tax to one of the lowest in any leading economy. Over the past thirty years, the main rate of corporation tax in the UK has fallen from 52% to 20%. In the same period, the top rate of income tax in the UK has fallen from 75% to 40%.

But there is no evidence that this strategy of reducing both corporation tax and top rate of tax for individuals has helped create wealth for the majority. Absolute levels of poverty in the UK have increased gradually in recent years, and there has been a dramatic increase in inequality. Britain is now ranked 28th out of 34 countries in the OECD equality league table.

In fact, there are very few economists who have ever actually been stupid enough to advocate ‘trickle down’ economics, since there is virtually no evidence anywhere that can conclusively support ‘trickle down’ or supply-side economic theory, even when the research had been conducted by right-wing economists. Recently, prominent right-wing economist Thomas Sowell, has even gone as far as denying that ‘trickle down’ theory has ever existed as a serious idea in economics!

When the right wing economists start to rubbish their own half-baked theories, they are also ridiculing policies that try to make businesses more profitable and promote wealth creation as an end in itself. If there is one thing that the research evidence clearly points to it is that policies that benefit business do not make us richer, but actually make us poorer. If this teaches us one thing it is that we need to stop listening to the business leaders who preach this nonsense and start making economic decisions that benefit us all.

This blog summarises one of the 10 Myths included in a forthcoming publication – The Mythology of Business by Professor David Whyte. The booklet, published by IER in association with CLASS, will be available from 12 August 2015 price £6. To reserve your copy download the order form, complete your details and return to IER with your payment.