Several economists and politicians have argued that taxes on businesses organizations and wealthy individuals should be reduced to encourage them to invest in the short term, thus stimulating economic activity and benefitting the society in the long term. This economic proposition has been called the trickle-down economics or trickle-down theory.
The concept prevailed in American politics beginning the 1920s. Numerous politicians from the Republican Party advocated for supply-side economic policies that included arguments for lowering the taxes of large companies to facilitate their expansion or other investment decisions. They believed that giving these businesses tax incentives would help increase their business activities, particularly their production outputs and workforce requirements.
Former U.S. President Ronald Reagan advanced a series of policies collectively referred to as Reaganomics during the 1980s. It included large tax cuts based on the signing of the Economic Recovery Tax Act of 1981 that lowered top marginal bracket from 70 percent to 50 percent and lowest marginal bracket from 14 percent to 11 percent.
Nevertheless, the positive effects of Reaganomics and the Economic Recovery Tax Act of 1981 seemingly strengthened the arguments for trickle-down economics. However, numerous economists and politicians are still critical toward this economic proposition, as well as the supposed positive effects of significantly cutting the taxes of large businesses and wealthy individuals.
The Arguments, Criticisms, and Evidence: What Is Wrong With Trickle-Down Economics?
Economist Thomas Sowell explained that the concept of supply-side economics does not claim to work in a trickle-down fashion. To be specific, he said that adjustments in marginal tax rates work in the opposite direction in which the public reaps the benefits and all other benefits flow in an upward manner toward businesses.
Another economist, John Kenneth Galbraith, mentioned that the U.S. already had its version of trickle-down economics during the 1890s under the name “horse and sparrow” theory. In referencing politicians and businessman David Stockman, he added that politicians used supply-side economics as a mere cover for the trickle-down approach to economic policies.
Note that major criticisms against trickle-down economics centered on claims that it only favors wealthy business owners and disadvantages their laborers, thus widening the gap further between the rich and the poor. Some critics would often note that politicians promote these policies to appease influential business owners and serve their personal interests.
Several studies have provided empirical evidence to support the arguments or criticisms against the concept. A 2012 study for Tax Justice Network spearheaded by economist James Henry revealed that the wealth of extremely rich individuals of the world do not trickle down to the local economies or the to the masses.
In analyzing data from the Bank for International Settlements, International Monetary Fund, and the private sector, the study specifically showed that capital amounting to USD 21 trillion flowed out of countries and disappeared into tax havens. Thus, it concluded that lax tax rules have allowed the super-rich to amass wealth and hide their money in offshore bank accounts. It added that the siphoning of private wealth has a negative effect on the home economy of these wealthy individuals.
Another paper by the International Monetary Fund published in 2015 that the rich only gets richer. It showed that the GDP growth declines over the medium term despite an increase in the income share of the top 20 percent or the rich, thereby indicating that the benefits do not trickle down. Meanwhile, an increase in the income share of the bottom 20 percent or the poor has been associated with higher GDP growth.
Economist Owen Zidar also published his findings in 2019. His study involved investigating how tax changes for different income groups affect aggregate economic activity. Results indicated that tax cuts for lower-income groups were positively related to an increase in employment. However, tax cuts on the top 10 percent of income share had small effects on employment growth.
Summary of the Arguments and Evidence
The following are the summary of arguments or criticisms and evidence against trickle-down economics:
• Critics have argued that politicians used supply-demand economic policies as cover for justifying trickle-down economic policies while arguing further that these politicians are either clueless about economics or are simply trying to appease wealthy individuals.
• Supply-demand economics do not suggest that benefits would trickle down from the affluent to the masses. Instead, it works in the opposite way in which the masses would first reap the benefits and such would transcend up toward businesses and their investors.
• Economist James Henry showed that the super-rich often siphon their private wealth out of their countries to hide them in foreign bank accounts or tax havens, thereby indicating that lax tax policies allow them to amass wealth without redistribution.
• The studies by the IMF and Zidar revealed that lowering the tax of wealthy individuals has little effect on economic growth and employment while lowering the tax of the poor has been positively associated with increased economic growth and employment rate.
FURTHER READINGS AND REFERENCES
- Dabla-Norris, E., Kochhar, K., Suphaphiphat, N., Ricka, F., and Tsounta, E. 2015. Causes and Consequences of Income Inequality: A Global Perspective. International Monetary Fund. ISBN: 9781513555188
- Galbraith, J. K. 1982, February 4. “Recession Economics.” The New York Review of Books. Available online
- Henry, J. S. 2012. The Price of Offshore Revisited: New Estimates for “Missing” Global Private Wealth, Income, Inequality, and Lost Taxes. Tax Justice Network. Available via PDF
- Sowell, T. 2012. Trickle Down Theory and Tax Cuts for the Rich. Stanford, CA: Hoover Institution Press. ISBN: 978-0-8179-1615-2
- Zidar, O. 2019. “Tax Cuts for Whom? Heterogeneous Effects of Income Tax Changes on Growth and Employment.” Journal of Political Economy. 127(3): 1437-1472. DOI: 10.1086/701424