Trickle-Down is Drowning the Middle Class

by Forgot About Keynes

At the beginning of a new two-part series on inequality, Jacques Peretti notes that: “when [he] was growing up in the 1970s, the idea that the aristocracy ruled Britain had gone, they were finished. But now there’s a new aristocracy who have taken over – they’re not the landed gentry, they’re the super-rich.”

Britain now has 104 billionaires – that’s more per head than any other country in the world. And the way that this group justifies its huge financial and political power is by recourse to trickle-down economics. Multi-millionaire Rob Hersov explains that the rich are good for Britain:

We want more super-rich people here in England. Why? Because if they invest here, if they hire people, if they use taxis, if they go to restaurants, they’re creating wealth for people in England. It’s not trickle-down, it’s trickle-through. They’re creating opportunities for other people.

Trickle-down is the theory that poverty can be eliminated in the least developed countries in the world through free markets and free trade and that GDP can be increased in the most developed countries through lower taxes for the richest. Arthur Laffer explains that:

Rich people are different than most people. The rich is the one group of people where you lower tax rates, you will get more revenues and every time we’ve raised those tax rates on the rich, they’ve paid less … If you tax rich people and give the money to poor people, you’re gonna get lots and lots of poor people and no rich people.

This doctrine is part of a wider set of ideas known as supply side economics, which emphasises that prosperity emerges when the government does least and allows the market the freedom to express itself most fully.

This revival of free market ideas has defined government policy on both sides of the Atlantic since the late 1970s. The facts of the matter however, contradict the claims made by the likes of Laffer and Milton Friedman. If trickle-down were working—if the poorest in society were being dragged up by the richest becoming more affluent, as Margaret Thatcher declared would be the case—it should mean that we are all getting richer (per capita). We are not, though.

Despite the usual dichotomy of ‘growth-enhancing pro-rich policy’ and ‘growth-reducing pro-poor policy’, pro-rich policies have failed to accelerate growth in the last three decades. So the first step in this argument – that is, the view that giving a bigger slice of pie to the rich will make the pie bigger – does not hold.

The second part of the argument – the view that greater wealth created at the top will eventually trickle down to the poor – does not work either. Trickle down does happen, but usually its impact is meagre if we leave it to the market. (Chang, 2011)

Ha-Joon Chang argues in 23 Things… that income and wealth will not trickle down if we leave the market to its own devices. The economic growth generated through tax breaks and freer markets requires government redistribution, or the poorest in society will not get any richer.

As it happens, the bailing out of the financial sector and the ensuing austerity in the UK has meant that GDP per capita (average earnings) has still not recovered to pre-2008 levels. And according to (Table 2 of) Credit Suisse’s Global Wealth Report 2014, the UK is the only member of the G7 where wealth inequality has increased since 2000.

The amount of the [UK’s] controlled by the richest 10% increased to 54.1% [in 2014], up from 51.5% in 2000 … [Meanwhile, the] increase in inequality has coincided with a boom in the number of rich and super-rich people in Britain. (Treanor & Farrell, 2014)

The picture is not a lot different across the pond. While the wealth share of the top ten per cent in the US has not increased since 2000, the gains from its economic growth are not being shared equally. The Washington Post reported in October 2014 that:

adjusted for household size, real median incomes haven’t increased at all since 1999. That’s right: the middle class hasn’t gotten a raise in 15 years … [and it] is poorer, too. Median net worth is actually lower, adjusted for inflation, than it was in 1989. Even worse, it’s kept falling during the recovery.

We can see therefore, that, instead of economic growth—the rising tide that was supposed to lift all boats—benefiting all equally, decades of tax cuts for the richest and fiscal austerity for the poorest has just made the richest richer. What this means is a worrying new trend in some parts of the west.

The lifestyle that the average earner had half a century ago—reasonably sized house, dependable healthcare, a decent education for the children and a reliable pension—is becoming the preserve of the rich … The economies of Britain and America may now be transforming into the same hourglass shape that once characterised those of emerging countries. (West & Nelson, 2013)

The problem, according to internet billionaire Nick Hanauer, is that we have had too much faith in trickle-down, too much belief that inequality would benefit us all … when in fact, too much inequality threatens capitalism itself:

Trickle down economics is as old as human civilization. We used to call it divine right … It’s simply the idea that I matter and you don’t. That what I do is indispensable and what you do is extra. It’s how we keep you in line.

No matter how much money I have, I cannot sustain a great national economy – only a robust middle class can do that … Capitalism, which is the greatest social technology ever created for creating prosperity in human societies does need some inequality, just like plants do need some water. But in precisely the same way that too much water kills plants by drowning them, too much inequality kills capitalism by drowning the middle class.

The middle class is vital to the health of the wider economy, Thomas Piketty tells Peretti, because it enables mass investment and mass consumption (which have been shrinking over the past few decades). If the gulf in income and wealth between the richest and poorest continues to grow he argues, the future of democratic society itself could be threatened.

The incomes and wealth of the super-rich in Anglo-American economies have been growing much faster than has been the case for the average. This has put a great deal of pressure on the section of society that we have come to know as the middle class – so much so that we may be witnessing its decline.

Elizabeth Warren’s interpretation of Piketty’s Capital was that it showed that: “wealth does not trickle down. It trickles up. It trickles from everyone else to those who are rich.” As Peretti puts it, we’ve reached a stage where the super rich have the money and we need it.

We need meaningful redistribution then, but what form should this take? In Piketty’s view:

It would be better actually, to have an annual tax on wealth. This is just a matter of common sense … When you have booming property values at the top end and booming top wealth portfolios at the top end, it would be crazy not to ask for a little bit more.

The ideal tool, for Piketty, would be a global tax on capital, coupled with greater financial transparency among nations. This is not going to be straightforward, he admits (due to the considerable level of international cooperation it requires), but he proposes this as ‘a useful utopia’ – useful in the sense that it may provide a reference point by which we can assess our progress.

We do not need to (nor could we) start at a global tax. It is enough to start at the regional level (the European Union, for instance) and work onwards from there. Further, many nations have already attempted similar taxes on capital, such as France—which has levied the so-called solidarity tax on wealth—though Piketty notes that this is riddled with loopholes.

It’s important to note that such a tax would not be designed not as a way of funding welfare states or replacing all other forms of taxation. Even if levied at a very small rate, such as 0.1 per cent, there would be benefits, economic and otherwise; the main purpose would be to rein in the destructive power of unregulated capital.

A 0.1 per cent tax on capital would be more in the nature of a compulsory reporting law than a true tax … It is important to understand that a tax is always more than just a tax: it is also a way of defining norms and categories and imposing a legal framework on economic activity. This has always been the case, especially in regard to land ownership. (Piketty, 2014: 519)

We currently rely on Forbes magazine for estimates of the distribution of wealth. A tax such as this would give us reliable information that governments could use to more effectively deal with financial crises and plan for the future of social spending.

There is no need, for instance, to resort to depositor “haircuts” (which actually amounted to the confiscation of thousands from ordinary individuals) as Cyprus did in financing its end of the bailout deal agreed with the EU and the IMF in 2013. There is also no need for austerity such as that in the UK which has hurt the least well off most. Greater international financial transparency in this way translates into greater accountability with regards to fiscal and social reforms.

The major results of Piketty’s study show that we should not be complacent about the nature of capitalism. While there are inherent forces within it that push it towards greater equality (the diffusion of knowledge and technology which enables countries such as China and South Korea to develop rapidly, for instance), there are also forces inherent within it pushing it towards greater inequality. The most basic ‘force for divergence’ as Piketty puts it, is a state of affairs where earnings on capital are allowed to outstrip economic growth (where r > g).

We need institutions and policies—beyond the twentieth century’s fiscal and social model—which counter this ‘implacable logic’ towards greater inequality and we must be willing to bring about the political integration needed to make them a reality.

If democracy is someday to regain control of capitalism, it must start by recognizing that the concrete institutions in which democracy and capitalism are embodied need to be reinvented again and again. (Ibid.: 570)

Piketty distances himself from Marx’s apocalyptic conclusions but warns that without sufficient change ‘the possibilities are not heartening’ (Ibid.: 27). Nevertheless, there is room for a reasonable level of optimism, he suggests. Beyond the diffusion of technology and skills, there are also labour market institutions that can be a force for greater convergence (reduced inequality).

Peculiarly, he notes, the national minimum wage in the US remains lower now in real terms than it was in the 1960s – this can be changed. There may also be a greater push towards unionisation as a means of protecting the livelihoods of workers and with any luck, fighting the senselessly out of proportion salaries and bonuses of today’s class of super-managers.

Piketty says that he’s “not terribly impressed” by those that profess to know what will happen in advance of the levying of taxes on capital, because much the same was prophesied of income taxes roughly a century ago, which have turned out to be a massive success.

What Piketty has captured, regardless, is that we have reached a critical point in economic development where the effects of capital on economic development need to be restrained by democratic means … or as he warns, we could have a return to the toxic politics of the 1930s and 1940s.

Piketty is not wrong to suggest that significant fiscal change is needed and he deserves a great deal of credit for putting inequality back on the agenda. There’s been a remarkable complacency among mainstream economists and policymakers since around 2010, since which it’s been assumed that the problems uncovered by the recent financial crisis have basically been dealt with. They have not and inequality remains a menace.

Many on the political right see Piketty’s proposals as too extreme and have been looking for anything they can to undermine him (Chris Giles has tried harder than most). I believe, however, that history will show Piketty to be a moderate. As he rightly argues, his proposal of (something approaching) a global tax on capital is a lot better than some of the alternatives we saw in the last century that may yet re-emerge: a widespread and prolonged protectionist spiral, or worse, the re-emergence of totalitarianism.

The lack of this kind of response is what has so far distinguished the Great Recession from the Great Depression and the recent rise in support for parties on the political far right in Europe warrants anything but the faith in the market espoused by many of Piketty’s detractors.

Elizabeth Warren insists that we have to have a debate (and we do) on economic rewards. Should it be those that work hard that are rewarded best or should it continue to be rentiers, those that essentially earn money for nothing? In the final analysis, Piketty deserves a great deal of credit for expressing the defining issue of our time in a manner that forces the economics profession to face something it would so much prefer to ignore.