Economic Theory

Forget trickle-down: In a free market, the rich don’t gain at the poor’s expense

A lie, repeated often, becomes the truth in the public mind. That’s why, when a Fox News commentator suggests that Birmingham is a “Muslim-only city”, we feel it important to set the record straight. Sadly, many lies and myths pervade public discussion of economics. No matter how often they are debunked, they return. Attempts to defeat them amount to a fruitless game of whack-a-mole.

We’ve all heard them. The best were outlined in my colleague Christopher Snowdon’s recent book Selfishness, Greed and Capitalism: “The rich have got richer and the poor have got poorer since the 1970s”, “Capitalism is predicated on greed”, “We are working longer and longer hours”. Never mind mansion taxes – a tax on falsehoods and straw men about capitalism would go a substantial way to plugging the gaping hole in the public finances.

My favourite lie is the idea that those who believe in free market capitalism subscribe to the commonly denounced theory of “trickle-down economics” – the idea that lower taxes on high earners are good for the economy because they leave the super-rich more money to spend. It must be true that we all think this. Barack Obama claims it is so. Paul Krugman agrees. Ha-Joon Chang, Ed Miliband, and The Guardian all know that those who believe in the power of free market economies subscribe to this failed doctrine.

Except we don’t. There is no record of any serious free market thinker ever outlining that cutting tax rates on high earners is good because it encourages the rich to spend. So it’s all the more baffling that the BBC has commissioned a series of programmes by Jacques Peretti, called The Super Rich and Us, where the premise is that the power of this idea has shaped government policy for 30 years.

Peretti is no stranger to bizarre theories. His recent offerings for the BBC have included The Men Who Made Us Fat and The Men Who Made Us Spend. Personal responsibility doesn’t seem to be on his ideological radar. This is fine, but we should expect more from a public broadcaster than to repeat theories nobody subscribes to, particularly when we are forced to pay for the privilege.

When they denounce “trickle-down economics”, Peretti and the figures above project their own worldview. For many of them, it is spending that matters to an economy – and they disagree that the rich having more money to spend is as beneficial as others having it following redistribution.

Yet free marketeers don’t believe in low taxes because of their effect on spending. They believe in low taxes because they provide a strong incentive to earn more income in the first place. And the best way to earn more in a competitive, dynamic, market economy is to provide goods and services people want. Low taxes can therefore engender the sorts of entrepreneurial activity that enrich our lives through better and cheaper products – the productivity improvements we recognise as economic growth.

If the decisions of Bill Gates or Ryanair’s Michael O’Leary are, at least at the margin, influenced by their personal post-tax keep, high tax rates on them would lead to worse outcomes for consumers. Free marketeers don’t believe in trickle-down, but trickle-up. We want to incentivise people to do things that fulfil wants and needs for all. If they get paid a lot for providing things we want (though a small fraction of the value they create), so be it.

This article was originally published in City AM.

Head of Public Policy and Director, Paragon Initiative

Ryan Bourne is Head of Public Policy at the IEA and Director of The Paragon Initiative. Ryan was educated at Magdalene College, Cambridge where he achieved a double-first in Economics at undergraduate level and later an MPhil qualification. Prior to joining the IEA, Ryan worked for a year at the economic consultancy firm Frontier Economics on competition and public policy issues. After leaving Frontier in 2010, Ryan joined the Centre for Policy Studies think tank in Westminster, first as an Economics Researcher and subsequently as Head of Economic Research. There, he was responsible for writing, editing and commissioning economic reports across a broad range of areas, as well as organisation of economic-themed events and roundtables. Ryan appears regularly in the national media, including writing for The Times, the Daily Telegraph, ConservativeHome and Spectator Coffee House, and appearing on broadcast, including BBC News, Newsnight, Sky News, Jeff Randall Live, Reuters and LBC radio. He is currently a weekly columnist for CityAM.

6 thoughts on “Forget trickle-down: In a free market, the rich don’t gain at the poor’s expense”

  1. Posted 13/01/2015 at 13:37 | Permalink

    “Yet free marketeers don’t believe in low taxes because of their effect on spending. They believe in low taxes because they provide a strong incentive to earn more income in the first place.”

    Some might. But I submit that most do so because of their effect on spending: I think both that (1) micro-planned private expenditure is better allocated than macro-planned state spending, and that (2) those engaged in free exchanges are entitled to the surplus they realise, and state spending ought to be kept as low as it properly can be in the recognition that taxation is a necessary evil.

  2. Posted 13/01/2015 at 14:19 | Permalink

    In ‘The Theory of Moral Sentiments’ Adam Smith seems to come pretty close to a ‘trickle-down’ theory. On pp. 184/5 of the 1976 bi-centenary edition edited by Raphael and Macfie he writes: “[The rich] are led by an invisible hand to make nearly the same distribution of the necessaries of life, which would have been made, had the earth been divided into equal portions among all its inhabitants, and thus without intending it, without knowing it, advance the interest of the society, and afford means to the multiplication of the species.” This is, of course, a different implication of the ‘invisible hand’ from that discussed in his later book ‘The Wealth of Nations’. Am I wrong to interpret the above passage from TMS as being close to a trickle-down’ theory?

  3. Posted 14/01/2015 at 13:29 | Permalink

    One of the problems is that Ryan may be right that those who believe in free markets don’t advocate the theory of trickle down, but many exceptionally wealthy and powerful people do, as evidenced by Perreti’s film. So it’s not simple a case of arguing against ‘lefties’, it’s also deciding which self-avowed ‘free marketeers’ are let inside your tent and which are called out.

  4. Posted 15/01/2015 at 03:32 | Permalink

    In a civilised society, you only pay for the burden you place on the community. Earning income, and buying capital benefits everyone. Unlike income and capital, Land, by definition, is unreproducible. Exclusive occupation of productive Land is therefore the only real burden we place upon the community*. It is the permission to exclude others that is the benefit we should be paying for. Measured by the market, as the rental value of Land. These Capitalist principals of fair compensation, should be how we pay for shared services, yet we tax income and capital. The top1% of households in the UK own 3 times more land by value than they currently pay in taxes. This is the ratio of economic parasitism. Its how wealth and welfare trickles up and not down, and why we see such large disparities in wealth. How is the Duke of Westminster’s billions ever going to be competed away after all?
    * other burdens, or negative externalities, include State granted monopoly rights, and pollution.

  5. Posted 18/01/2015 at 20:41 | Permalink

    There has been a massive transfer of wealth and income from working people into the pockets of the rich and powerful since the Thatcher/Reagan debacle.

    Is that what is meant by trickle-u?

  6. Posted 18/01/2015 at 21:57 | Permalink

    Why do all these ‘trickle-up’ zealots fail to mention the fact that the economy is still operating as result of taxpayer bailouts?

    Why is neoliberalism such an embarassing, miserable failure?

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