Tax cuts for the rich - do they really work?

Of late, tax cuts for the rich "to stimulate the economy" have become very fashionable. Especially among the rich and those politicians who hope to receive campaign contributions from them, it has to be said.

The concept even has a name... "trickle-down economics".

The idea is that if the government cuts your tax bill, you'll spend at least some of the savings in your local shop. The shopkeeper might then spend their extra profits on a nice meal in a local restaurant. The restauranteur will, in turn, buy more produce from the local farmer, and so on.

For every extra pound, dollar or euro in tax cuts, the theory goes, money cycles through the economy and everyone is better off.

But, as Albert Einstein said, "In theory, theory and practice are the same. In practice, they are not."

Like a lot of business and economic concepts, the theory of trickle-down economics isn't completely crazy, it's putting it into practice where things go astray.

And, of course, if you're looking for somewhere that fundamentally decent ideas routinely career over the edge of a cliff before hurtling, Roadrunner style, to the bottom of a deep ravine attached to an Acme anvil by a piece of string, government decision-making is usually a great place to start.

Here's why.

The current fashion for tax cuts for the rich means governments are in fact prioritising tax cuts for people who aren't going to spend the extra cash they've been given...or, to the extent they do, it's not going to be on things that spread the love (and the cash) around like our homely example of the shopkeeper, the restauranteur and the farmer earlier.

It's pretty much a straight hand-out of taxpayers cash...including tax paid by low and middle-income taxpayers, it has to be said...to people who already have plenty of their own. What's more, in practice, very little of it is going to trickle anywhere.

The same is true of tax cuts for giant corporations, versus tax cuts for small and medium-sized businesses.

Think about it. If tax cuts go to people who already eat out for breakfast, lunch and dinner, they physically can't eat any more meals in a day. They probably don't buy much from their local shop, unless they happen to live within walking distance of Harrods. Their only interest in farming comes from the family farm they bought as part of an Inheritance Tax avoidance scheme a few years ago (yes, that really was a thing...).

Here's what they do instead.

They stick the money in a bank because they already have everything they need. They've got the house paid off, several cars, the school fees covered and as many holidays and gadgets as they want.

Of course, sometimes they splash out. Maybe they buy a new Porsche, which is great news for the German automotive industry, but provides few benefits for our own economy.

Perhaps they take two "holidays of a lifetime" each year instead of one. That might help bolster the coffers of cruise lines based in international tax havens and swanky hoteliers in far-flung destinations, but it doesn't do much for anyone else.

Or they use the extra cash to add another buy-to-let to their property portfolio or invest in the stock market...both of which push up asset values to unsustainable levels, making it even harder than it already is for ordinary people to afford a home of their own or save for their retirement.

You see, the problem with trickle-down economics isn't that the concept doesn't work. In fact, it works far better than the running average for economic concepts.

The problem is, for it to work, you've got to give the money to people who are going to spend it in ways which generate economic activity. Not to people who don't need it, and won't spend it.

Cutting taxes for the already-wealthy isn't going to benefit the country much if whatever trickling-down there is only benefits international tax havens, German automotive manufacturers and stockbrokers.

Not that I'm against wealth or capitalism. I'm very much in favour of both.

But, simply put, giving tax cuts to already-wealthy people might sound like a good idea at first...especially to already-wealthy people.

There's even the warm glow of being able to claim that you're "stimulating the economy" as you order that new Beemer or book that cruise to Hawaii. But if the proceeds of tax cuts are just put in a savings account or spent on fripperies and indulgencies, the net benefit to the economy which bestowed the tax cut in the first place is minimal.

Fair enough, you might say, capitalism is a winner-take-all sport...good luck to those stockbrokers, investment bankers, cruise line owners and international tax havens for being smarter than the government.

Well, frankly I've bought bread that's smarter than the average government, so that's not a terribly high threshold. But even this perspective overlooks one very important point.

Giving tax cuts to people who are actually going to spend the extra cash benefits the wealthy too. In fact, it could benefit them by much more than if they snaffled all the tax cuts for themselves like Scrooge McDuck.

Now, in case you think this sounds like dangerously left-wing nonsense, this is not dissimilar to the approach ardent capitalist Henry Ford took 100 years ago at the dawn of the automobile industry.

Henry Ford paid his workers much more than they could earn elsewhere. While it wasn't done purely for this reason, one by-product of his approach was that his production workers they could now afford to buy the cars he made.

So he sold more cars, amortised his fixed costs over a larger number of vehicles and made more money for himself. Rather than the automotive industry having just a few thousand ultra-wealthy people as potential customers, tens of millions of ordinary working people could now afford to buy a car.

Counter-intuitive though it seems, Henry Ford grew fabulously wealthy as a result of "overpaying his workers".

Tax cuts for the less well-off works in a similar way. Now more people can afford to upgrade their lives. And, by and large, they do it by spending money in ways which generate activity in the real economy in towns and cities across the country, not sticking it in the stock market, buying another rental property or going on a cruise.

Unlike the already-wealthy, who already have just about everything they could wish for, the less well-off already have a long list of things they'd love to spend some money on, if only they had any.

New shoes and clothes for the kids, ballet lessons, the occasional trip out, a healthier diet, gym membership...who knows, but the key here is that most of the benefits of their new-found cash will be spent in the local economy, improving the lives of others across their community, who will then have more money to spend in their turn.

Similarly for small and medium-sized businesses, as opposed to giant multinationals.

For several years now, giant multi-nationals have had access to as much cash as they needed at ultra-low interest rates to fund just about any investment they could possibly want to make. Give them some more cash in a tax cut and they'll not know what to do with it - in the last big US tax cut, large corporations bought back nearly $600bn of their own shares, returning the money to their shareholders who were, predominantly, among the already wealthy themselves.

Small and medium-sized businesses, on the other hand, already know the new member of staff they'd love to be able to hire, creating more employment in their local community, or the capital investment they've been wanting to make for years but never had the spare cash for.

That's why there's nothing wrong with the principle of trickle-down economics. It's just that in this, as in so many other things, politicians have taken a decent-enough theory but mangled it so thoroughly as to render it largely impotent in practice.

For trickle-down economics to work, the benefit of tax cuts has to go to low and middle-income people - the people who will actually spend the extra cash in their local shops, restaurants, farms, theatres and music venues. And to small and medium-sized businesses so they can hire that new member of staff from their local community or invest in capital equipment to make their business more efficient and productive.

Then the benefits "trickle down" to the wealthiest in society, all of whom, as Henry Ford did, become richer themselves by helping other people become better off.

Trickle-down economics works fine when you put low and middle-income earners, and small and medium-sized businesses at the top of the pyramid rather than the already-wealthy and the global multinationals.

Not only that - everyone, rich and poor, becomes better off by prioritising the benefits to people and businesses who are going to spend their new-found surplus in the local economy....and not just better off financially.

Society becomes more cohesive. The world is a more secure, more comfortable place for everyone. Social problems reduce significantly, meaning tax revenues can be invested in the things the country really needs...like better infrastructure and a properly funded education system...instead of being diverted to cover the much greater costs of patching-up a broken society.

And it gives more people the dignity of contribution. When someone goes from earning ￡15,000 a year to ￡25,000 a year, they don't complain about the extra tax they pay. They're happy to pay the extra tax because now they can support their family better. They see improvements in their children's schools. And they see the infrastructure and public services around them improve...due, at least in part, to the extra tax they pay.

Cut taxes for a large multinational corporation or someone on the Sunday Times Rich List and they never stop moaning about the millions of pounds in tax they still pay every year. Even though, as another arch-capitalist - Warren Buffet this time - has highlighted, it seems more than a little unfair when the provisions of the tax code mean multi-billionaires like him pay a lower effective tax rate than his office receptionist and his cleaner.

Trickle-down economics really does work. But for it to work, the tax cuts need to go to people and businesses who'll spend the extra cash instead of hoarding it away in their savings accounts or frittering it away on another status symbol.

Maybe it's time for a rebrand. Instead of trickle-down economics, perhaps we should call it "trickle-up" economics.

Governments might then prioritise the right people to make the concept work as it should, moving the theory and the practice of trickle-down economics a lot closer together.

If they managed that, I'd be delighted. And even Albert Einstein might be impressed.