It took Liz Truss just 45 days to destroy Margaret Thatcher’s life’s work. For 40 years the idea that tax cuts for the rich would trickle down to help the poor has not just dominated the rhetoric of Western politicians but aligned the ambitions of those who already have the most and those who wish they did.
Truss’s tax cuts, however, were so excessive and so poorly timed she actually forced London’s bankers to admit they were bad for the economy and the British middle class to admit they were bad for society. Perhaps most significantly, she even forced Conservative politicians to admit that collecting more tax to help more people is a good idea.
Financial markets provide a narrow and imperfect lens through which to evaluate government policy, but one thing they do well is give an instantaneous assessment of whether government policies will help or harm those who own the most shares, which is what was most remarkable about the market reaction to Truss’s budget.
The day after Truss’s chancellor of the exchequer, Kwasi Kwarteng, announced his unfunded plan to scrap the top tax rate and cut the company tax rate, Britain’s exchange rate fell sharply and interest rates surged. As pension funds faced collapse and those with mortgages feared bankruptcy, the Bank of England stepped in to fight the effects of the Truss government’s policies.
The intervention of Britain’s central bank helped calm the nerves of some investors, but it’s hard to calm a crowd when someone keeps yelling “Fire!” When Truss went on radio to explain her plan in greater detail, the exchange rate lost all the ground the Bank of England’s intervention had delivered. When her chancellor hinted there might be even more tax cuts to come, the pound fell to a record low.
There was never any good evidence to support trickle-down economics. The idea that cutting taxes for high-income earners would lead to higher spending and more jobs has obvious appeal for those who get both the tax cuts and more money for shopping. But spending on free childcare instead of tax cuts creates jobs too, both for the people employed in childcare and for the parents who can then afford to search for work. The childcare workers, it’s worth noting, also spend their money in local shops.
The power of trickle-down economics has never been its economic logic but rather its political logic. Thatcher created a suite of rhetorical and policy tools that consistently united middle-class and high-income voters in the belief that the lower their taxes, the better their country would be. The genius wasn’t selling the direct benefits of tax cuts to those who would get the cash, it was arguing that helping the rich was actually the best way to help the poor. And so “compassionate conservatism” was born.
According to Thatcher’s playbook, low tax rates boost after-tax salaries and, in turn, give people more incentive to work hard and more ability to spend. At the other end of the spectrum, Conservatives typically argue that unless unemployment benefits are brutally low, low-income earners will have no incentive to search for work. While cutting taxes for the rich and being hard on the poor might seem nasty, trickle-down economics reassures us that you have to be cruel to be kind.
Conservatives around the world have been incredibly successful in convincing voters that the best way to help those with less than you is to give tax cuts to people with more than you. So much so that many labour parties around the world, especially here in Australia, have embraced the same language and policy ideas. But as any economist who’s been to a dinner party knows, economics has never been a popularity contest. Just because a lot of voters like hearing that they deserve lower taxes and that other people deserve less welfare, doesn’t mean it works.
After 12 years of Conservative Party rule, the British economy is lagging well behind its continental neighbours. The once free-trading Conservatives argued that Brexit would invigorate their economy and, bizarrely, free up enormous amounts of spending for the public health system. Neither happened and Boris Johnson’s defining economic policy had the predictable effects of driving jobs and investment offshore while causing a surge in paperwork at the border and prices in the stores. While Johnson’s decision to let Covid rip before vaccines were rolled out was a bit more libertarian than exiting the European free-trade zone, it was no more effective in boosting the economy.
So what was a newly elected Tory prime minister to do? The economy was languishing on her party’s watch, with gross domestic product still smaller today than it was before Covid-19 hit. While the eurozone had managed to grow by 1.8 per cent since the pandemic started, and the big-spending Democrats in the United States had delivered 3.5 per cent, Johnson had taken the British economy backwards. Truss clearly thought it was time to be bold.
In 2012, Truss, Kwarteng and three other up-and-coming Conservative MPs penned a book titled Britannia Unchained, in which this next generation of Tory leaders spelled out their low-tax, low-spending, devil-take-the-hindmost approach to economic reform. It is never easy to distil the essence of an entire book in a few words but some authors make it easier than others. According to Truss and her colleagues, Britain was a “bloated state” with “high taxes and excessive regulation”. They went on to tell British voters, “The British are among the worst idlers in the world. We work among the lowest hours, we retire early and our productivity is poor. Whereas Indian children aspire to be doctors or businessmen, the British are more interested in football and pop music.”
It’s not hard to understand why, 10 years later, when they got the chance to govern those “idlers”, their government almost immediately collapsed. Thatcher was smart. She chose her words and her policies carefully. The compassionate part of compassionate conservatism was central to her political success. Truss and her crew were proud of how nasty they could be to the poor, and not even the rich thought they were well placed to preserve their wealth.
London’s financial markets couldn’t believe a government with spiralling debt and rising inflation would spend £45 billion on tax cuts that would simultaneously drive public debt and inflation even higher. And the British voters couldn’t believe that, as the cost of energy was soaring and their real wages were falling, their government would deliver so much cash to those who already earned the most. Where Thatcher had united the financial markets and middle-class voters in their hostility to paying tax, Truss united them in their hostility to tax cuts. It was quite a feat.
Now that the politics of cutting taxes has been disrupted by Truss’s overreach, the economic case for shrinking the state and expanding inequality will come under much greater scrutiny than it has in decades. This is good news for those who argue the stage three tax cuts promised in Australia are unfair and should be scrapped.
The easiest way to test the claim that lower taxes and a smaller public sector make an economy more productive and competitive is to simply compare the performance of countries that embraced neoliberalism with those that didn’t. Unfortunately for those sweating on their next tax cut, the countries that most ignored Thatcher’s economic advice have delivered the most prosperity for their citizens. China, a communist state with an enormous public sector and a top tax rate of 45 per cent, has lifted more people out of poverty in the past 30 years than all other countries combined. The same pattern is true for rich countries.
The Nordic countries have much bigger public sectors than the average, and far bigger public sectors than Australia. They also have much higher taxes, much higher spending on social services, and, inconveniently for some, much more productive economies as well. To rub salt into the wounds, they also systematically rank near the top of global wellbeing indicators such as the United Nations Human Development Index.
While Thatcher’s preference for cutting taxes, cutting services and cutting wages gained powerful support, mainly from the powerful, the Nordic economies have thrived by ignoring neoliberal policy and politics. Forty years of data shows that dividing people is a good way to build a voter base but a bad way to build a sense of community or a productive economy.
Like Britain, Australia has spent decades pursuing income tax cuts, company tax cuts, privatisation and labour market deregulation. Our business and political leaders told us it was to drive productivity, but what it really did was drive deep divisions in our community and chronic underinvestment in health, education and transport. As luck would have it, these policies drove profits to record highs and wages to record lows.
Australia can set about building the economy and society of the future. Already there are some encouraging signs. The Victorian government is rebuilding its publicly owned State Electricity Commission. The Queensland government is investing directly in renewable energy generation. Even the former Coalition government committed funds to nationalised investment, including Snowy 2.0, the inland rail and the national broadband network. But the elephant in the room remains the ongoing refusal, from Labor or the Coalition, to admit the obvious truth: that Australia needs to collect a lot more tax if it is to thrive in the 21st century.
Scott Morrison announced his stage three tax cuts in 2018 but it is Albanese who has promised to deliver them in 2024. Morrison was smarter than Truss. He made sure he was around to get the applause without facing the fallout of suddenly introducing them. But while political management revolves around perception, economic management revolves around reality.
According to the parliamentary library, the stage three tax cuts are seven times bigger than Liz Truss’s. While they might not have spooked the Australian markets, because they were so far off in the future, they will shred the revenue base on which Australia’s public services are built. The Albanese government now has 18 months to decide if it wants to keep relying on Thatcher’s playbook, or rely on the economic evidence instead. It’s not yet clear which way it will jump, but it’s telling that, even in the home of Thatcherism, Conservatives have rejected Truss and embraced the need to collect more tax.
This article was first published in the print edition of The Saturday Paper on October 29, 2022 as "Trickle of the trade".
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