The trickle down economics method was used by ancient policy makers to strengthen a country’s economy.
This is especially favored in times of economic uncertainty when large corporations and business owners were called upon to help rejuvenate and drive growth.
Governments provide favorable tax breaks to higher income brackets and offer incentives to large corporations to encourage them to invest and help increase employment opportunities.
The idea is that if big companies and business owners reinvest or grow their business, the wealth from the top can trickle down to ordinary people on the ground via job creation.
In particular, former US Presidents Ronald Reagan and George W. Bush were strong supporters of this approach. Until today, it is still a guiding economic principle of the Republican Party in the United States.
Against the backdrop of today’s inflationary climate and the hawkish direction of the Federal Reserve (Fed) on rate hikes, I would like to draw attention to “Reagenomics”, which was a term that proponents attribute to Reagan’s economic policy because they believed it ended the recession of the 1980s caused by runaway inflation.
At the time, Reagan reduced the top tax rate from 70% for those earning more than US$108,000 (RM508,410) to 28% for those earning US$18,500 (RM87,088) or more. It also reduced the corporate tax rate from 46% to 40%.
This was a landmark achievement of the Reagan administration. However, was it really Reagan’s economic policy that fixed everything?
The disruption of capital markets
We should note that the tools in a government’s pocket are not just to adjust tax rates. There is fiscal policy and there is monetary policy. The two go hand in hand and must work in tandem to achieve an optimal result.
Central banks manage monetary policy by intervening in financial markets through interest rates, buying and selling bonds among others, effectively controlling the money supply.
The government itself then manages the economy through policies such as budgetary expenditures, which include infrastructure development, social assistance distribution, etc.
Subject to the economic situation of the day, policies will be adjusted accordingly. What is important to note is that tax collection is still the primary source of revenue for a government.
If a government decides to be generous with tax cuts, the precondition should be that the government must have a strong balance sheet to support the gap between lower tax revenues and budget expenditures.
In this context, it should be remembered that under the Reagan administration, the American economy was going through galloping stagflation (high inflation and slow growth). It was then Fed Chairman Paul Volcker who took the extreme route of raising interest rates to 20% to control inflation.
This led to a recession. Thus, the trickle-down economic policy of “reagenomics” was never really tested and, essentially, it was more monetary policy that laid the foundation for the subsequent economic recovery.
History tends to repeat itself. As the UK battled high inflation and faced a looming recession, new Prime Minister Liz Truss was eager to demonstrate her ability to pull the country out of its challenges.
Whether it was she, her ministers or her advisers who chose to put forward a “Reagenomics” type policy when formulating the mini budget, it was clear that this was both a premature decision.
Cutting taxes for high earners and removing tax increases for corporations were never going to be able to stimulate consumption or encourage investment. In fact, inflation affects the rich the least and hits the poor the most.
On the contrary, a generalized tax cut for low- and middle-income segments of society would do more to support the economy.
But the nail in the coffin was when the bond market plunged as investors spooked by the unfunded fiscal outlays proposed by Truss and his team.
Where would the money come from? This is a crucial question, especially after the significant quantitative easing initiated by central banks around the world, including the Bank of England, over the past two years to weather the pandemic.
Quoting Warren Buffet, “Inflation cheats everyone.” She ended up going down in the history books as Britain’s shortest prime minister with a tenure of just 44 days.
Voting pattern affects policies
The idea of a democracy has always been one person one vote. Everyone has a say in the election. It is also the only time when politicians are held accountable for their actions and conduct.
Therefore, it is no exaggeration to believe that the mass voting model will have a direct impact on the policies of those in power.
I have seen many polls done and above all, economic concerns are at the forefront of people’s concerns.
With wealth disparity increasing over the years, the top 1% of the population controls 45% of global wealth, according to the Credit Suisse Global Wealth Report 2022.
A stable society cannot have great inequalities, otherwise it will lead to instability. History has shown us that the greatest empire collapsed because those in power failed to recognize their role as guardians and stewards of society.
Personally, I don’t believe in usurping and undermining the effort of entrepreneurship by penalizing those who get rich through years of hard work and sacrifice.
For example, I do not subscribe to the likes of windfall tax. However, I believe that favorable tax incentives should be put in place to encourage entrepreneurial, philanthropic and altruistic efforts.
Furthermore, to narrow the gap, broad-based policies should be formulated instead.
Before parliament was dissolved, the government then tabled the 2023 budget, which happens to be the biggest ever. There were concerns about the source of revenue for government budget expenditures in the coming year.
Truss’ downfall was due to the misjudgment in political decision-making that led to an upheaval in capital markets. Another important aspect was that his administration tabled a mini budget without a forecast by the UK’s budget watchdog, the Office for Budget Responsibility.
Therefore, it is imperative for the new government after the elections to allay concerns over the source of revenue and ensure that populist measures do not override fiscal responsibility.
Close the gap
Although the United States and China are currently at an all-time low in diplomatic relations, I have observed that there are similarities between the current administration of President Joe Biden and the policies of President Xi Jinping.
The former advocate building the country from the middle and 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, reiterates the country’s position to achieve moderate wealth for all instead of wealth concentrated at the top.
Much like climate change and the green agenda, most policy makers are doing their best to formulate policies in line with the trend of the times. Governments can do no harm when they champion the reduction of the income inequality gap between people.
Although the effects are not immediate, improving people’s lives and lifting them out of poverty will ensure the sustainability of a nation’s economy in the long term.
Hann is the CEO of Tradeview Capital. He is also a lawyer and author of Once Upon A Time In Bursa. The opinions expressed here are those of the author.