John Maynard Keynes - “ Taxation may sometimes be so high to defeat its objective of balancing the budget that a reduction of taxation will run a better chance, than an increase”. This is something very similar to the Laffer curve’s argument that we study in econ 101.
In 1896 in his horse and the sparrow theory, John Kenneth Galbraith said, "If you feed the horse enough oats, some will pass through the road for the sparrows." This is the essence of Trickle-down Economics. In simpler words, Trickle-down theory states that cutting taxes on the rich would encourage them to invest and work more, thus creating more jobs and benefiting everyone on the economic spectrum. This is not the first time one is reading about trickle-down economics, although the truth is that there is no evidence about which economist introduced this theory. According to Thomas Sowell, this term (trickle-down) is not an economic theory but a phrase hacked by politicians.
It is essential to understand the impact of tax rate cuts in a sequential way. What is the effect of tax cuts on the government’s revenue? Does it go up or go down. In recent US history, tax cuts happened four times (leaving the latest Trump administration tax cuts) in the 1920s, 1960s by John F Kennedy, 1980s by the Reagan administration, and the Bush administration in the 2000s. However, empirically it has been seen that tax collections went up after tax cuts in all four cases. If it has been empirically noticed that such tax reductions lead to increased tax revenue collections, policymakers must decide where they need to spend. There is a general misunderstanding among people about tax rate cuts and revenue collections and the former’s impact. The Government of India in 2019 announced corporate tax cuts amidst the economic slowdown, and the reasoning provided was to attract FDI and promote its Make in India policy. It is debatable whether it would have helped tackle the economic slowdown or not. According to a press note released by the government, it would lose around ₹ 1.45 lakh crores of the revenue it would have otherwise earned. However, it will be only exact after the final estimates of FY2021 only as the impact of such policies need to be studied over time.
Proponents of tax rate cuts on the wealthy believe that there will be anticipated changes in behaviour because of tax rate reduction. When tax rates are high, investors try to exempt taxes by putting that capital into ventures where no tax has to be paid or take tax-havens. On the other hand, those who oppose tax cuts on the wealthy claim that advocates of these tax cuts want to see higher-income taxpayers have more after-tax income, and then their prosperity will trickle down, which they believe doesn’t happen.
A recent study by two London-based scholars David Hope and Julian Limberg found that cutting taxes on the rich only helped individuals, directly affected while increasing income inequality and having no effect on the growth in the short term or long term. Through such policies, only top income shares rise, with little impact on economic performance. This research proves to be a significant counterpoint to the US's policies during Ronald Reagan's regime. The researchers also claimed that this was also applicable to the tax cut done by Donald Trump in 2017.
A lot of discussion pre-budget was done on the expectations that the government might impose some type of a covid cess on the wealthy in the form of increased capital gains tax or corporate tax. However, that did not happen in India, but many countries worldwide have raised taxes on the wealthy. In December 2020, Argentina introduced a one-off levy tax on millionaires, which is also dubbed as the “millionaire’s tax.” The U.K government was even thinking of a similar kind of one-off wealth tax. Taxing the wealthy has been more comfortable in some political situations, and in some, it is not.
The opposite of trickle-down economics is build-up economics. As per this model, the wealthy should pay for both the pandemic today and invest in the public's long-term well-being. This model holds that everyone, including the rich, would benefit from this. However, this may not be the best solution for governments but can help them provide relief in the short run to cope with the pandemic’s financial costs. Often, governments prefer such policies when the countries are in some crisis. However, there is a need for research to understand whether build up economics reduces inequality.
Edited by: Ayush Bakshi