Trickle down economics and the zero-sum fallacy
We need to stop fighting fires and start fighting arsonists
James O’Brien seemed to be on the verge of a nervous breakdown yesterday after the Chancellor announced a series of tax cuts for the rich (if you define ‘the rich’ as anyone earning more than £12,500 a year). Like George Monbiot, he was frantically tweeting about ‘dark money think tanks’ and the Institute of Economic Affairs in particular.
O’Brien and Monbiot have been crying wolf about the supposed stranglehold of free market think tanks over successive governments for so long that their hysteria may fall on deaf ears outside their echo chambers. This is ironic because, as Tim Montgomerie’s tweet above shows, there is an element of truth in it this time.
But only an element. Although Truss and Kwarteng have been good friends to the IEA over the years, Britain is not, alas, the IEA’s laboratory and it is a push to say that we’ve been ‘advocating these policies for years’. The energy price cap certainly wasn’t an IEA policy (we called it “middle class welfare on steroids”) and in all my years hanging around the Westminster think tank scene, I don’t recall unfunded tax cuts being a central plank of free market thinking.
While many people on the left have suddenly become fiscal hawks in the last 24 hours, most of my colleagues would still, I think, like to balance the books. If there was cheering from ‘Tufton Street’ [sic] yesterday, it was because the mini-budget represented a change in direction, from endlessly borrowing money to prop up a zombie economy to borrowing some money in the short term to turn the economy around. Everybody agrees that we need more economic growth (alright, not quite everybody) and there is a sense that Team Truss understands that this will not come about through central planning (Theresa May) or boyish enthusiasm (Boris Johnson).
As I said on Great British News last night, the mini-budget is nowhere near enough to transform the economy, but if it is the first installment in a series of growth-focused reforms, there may yet be a way out of the woods for an economy that has been in a 13 year slump.
It bears repeating that there were not £45 billion of tax cuts announced yesterday. £19 billion of it comprised a planned corporation tax hike that will not now come into effect. The correct figure is around £26 billion, still a fair sum although it is only 1% of the national debt and it will be lower in practice if the cuts lead to more economic activity, as I’m sure at least some of them will. Even the politically toxic removal of the 45p income tax rate - which, as much I enjoy ‘owning the libs’, might have been better left for another day - could help grow the pie.
Endless graphs from the likes of the Resolution Foundation showing the distributional effect of the tax cuts miss the point. They do not even attempt to factor in the dynamic effects of increased employment and better paid jobs and they implicitly assume that the government’s primary task is to dish out money to help people get by in a broken system, rather than fix the system itself.
Let me give two examples of broken systems that sap growth and make us poorer: housing and childcare.
The way fresh-faced millennial free marketeers bang on about house building and planning laws can be tedious, but they only talk about them so much because they are vitally important and they never get fixed. The obvious reason why high house prices are bad is that rents and mortgages take an ever-growing share of people’s incomes while boomers get rich on unearned wealth. But they also stop people moving to places where they can be more productive. They actively prevent economic growth.
Rather than fix the housing market, governments give people money to pay their rent and devise useless schemes like Help to Buy. The left don’t seem to have a problem with the government spending £20 billion a year on housing benefit, despite the fact that it amounts to a state subsidy for landlords and keep rents artificially high. The cut in stamp duty will help first time buyers and is a good thing, but it must be followed by planning reform to allow supply to meet demand.
The cost of childcare in Britain is also hellishly expensive and prevents economic growth by deterring young mothers from getting back to work. If you have a couple of young children, your marginal hourly income after childcare costs can be counted in pennies. Reasonably enough, many women decide that it makes more sense to stay at home and do the childcare themselves.
The government’s response is to spend £7 billion a year giving people ‘free’ childcare, but the real problem is that childcare in Britain is massively over-regulated and people who are inclined to set up a nursery are deterred from doing so by financial and bureaucratic barriers to entry. This broken system therefore creates economic inactivity twice over, firstly by preventing mothers from returning to work and secondly by preventing would-be childminders from earning an income.
Such examples of the government acting as both arsonist and fireman could be multiplied many times over (I have not even mentioned our failure to be self-sufficient in energy). None of it is going to be much improved by taking a penny off income tax, but that element of the mini-budget was more of a response to the recession that we are (probably) already in. Borrowing money and cutting taxes is a completely uncontroversial thing to do in a recession, and it is certainly more sensible than paying people £2,000 to scrap their cars, as Labour did in the last one.
But the rest of the mini-budget was about making Britain a more attractive place to do business, start a business and expand a business. It was about making economic inactivity less appealing and making work more rewarding. It recognises that even a mere 1% increase in GDP gives us another £25 billion to spend. It had nothing to do with the idiotic concept of ‘trickle down economics’ in which governments supposedly give tax breaks to the rich in order to keep the girl in the Rolex shop in work.
The fact that leftists think that anyone seriously believes in ‘trickle down economics’ reveals a lot about them. It is easy to mistake money being circulated with wealth being created. Two and a half centuries after Adam Smith wrote An Inquiry into the Nature and Causes of the Wealth of Nations, I suspect economists underestimate how few people understand either the nature or causes.
It doesn’t matter whether wealth trickles up, down or sideways. Trickling is not sufficient to create growth. If merely circulating money increased GDP, humanity wouldn’t have existed for so many centuries in a steady-state economy. What matters is the value added. Greater efficiency. Technological advancement. Making full use of people’s talents. Productivity gains.
Funnily enough, the only people who actually use trickle down arguments are leftists when they argue that higher education should be ‘free’ because graduates will pay more tax in later life, or when they extol the (usually nonexistent) multiplier effects of various state-funded white elephants. It is perhaps not surprising that public sector workers and university academics see economics as a zero-sum game since they are constantly fighting for their slice of a fixed budget in their daily lives.
After a decade of stagnation, it might feel as if economics is a zero-sum game, but it does not have to be. It is unfortunate that the income tax cuts overshadowed the other elements of the mini-budget and gave the impression that the government thinks that cutting income tax alone is sufficient to turbo-charge the economy. I am sure it doesn’t think that and I expect there to be some serious pro-growth reforms ahead.
That is when the real battle will begin. Vested interests and single issue fanatics will portray any deregulation, no matter how moderate and logical, as the road to ruin. Messrs Monbiot and O’Brien have a lot of wailing yet to do.
Cretins like O'Brien and Monbiot make their living by taking crumbs of truth and weaving them with lies, half-truths and utter nonsense into their hand-wringing dialogue that LBC and the BBC, et al, give provide a non-questioning platform to spout their nonsense, accepting their line as proven fact and never querying what they say.
Cretins like O'Brien and Monbiot make their living by taking crumbs of truth and weaving them with lies, half-truths and utter nonsense into their hand-wringing dialogue that LBC and the BBC, et al, give provide a non-questioning platform to spout their nonsense, accepting their line as proven fact and never querying what they say.