The Lie Of Trickle Down Economics

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Trickle Down Economics, popularized as Reaganomics, is simply a pseudo economic theory that aims to benefit the ultra-rich while masquerading as something that can lift the poor out of poverty.

This ‘theory’ advocates tax-cuts for the rich, stating that more income for the rich can effectively lead to employment generation and greater income returns for the poor, since the wealthy will obtain more money which can be invested further. Thus, it can be considered as a subset of supply-side economics, which deals with tax-cuts for society as a whole.

In Trickle Down Economics, corporate taxes are cut; taxes may be cut for wealthy taxpayers as well. So, essentially, the private sector benefits from a higher level of income. Thus, wages for workers increase, new factories pop up everywhere, and people are incentivised to invest more- all of which leads to a boom in income generation.

This widespread economic growth, in turn, leads to more revenue for the government, since they collect more through income tax revenues, which more than compensates for the money they initially lost due to the tax cuts.

In theory, all of this sounds well and good. It makes sense too, does it not? The ultra-rich have more money than ever in their hands, which they can invest into the economy. This will lead to the poor receiving the ‘bread-crumbs’ that fall off the table- in other words, money that trickles down. The government benefits too!

It has worked to some extent in practical situations, though the true causes remain unclear. After all, correlation is not equal to causation. For example, this theory played a role in ending the 1980 US recession.  According to sources, Reagan cut taxes- from 46% to 40% for corporates and to 28% for anyone earning above $18,500. Defenders of the theory often cite this as evidence of Trickle-down economics being valid.

At the same time, however, he increased government spending, almost tripling the Federal debt from 1981-1989. Thus, it is just as likely that the massive government spending helped end the recession, rather than the tax cuts themselves. Of course, this part is oft ignored and omitted, so that a favourable view of the theory can be promoted.

More recently, in 2017, President Trump signed the Tax Cuts and Jobs Act, resulting in a reduction of corporate tax rates and tax rates for the rich. According to a study by the Tax Policy Centre,  based on this act, “on average in 2027, taxes would rise modestly for the lowest-income group, change little for middle-income groups, and decrease for higher-income groups.” In other words, not even close to what the move was touted to be. Trump even said that the act would help compensate for the loss incurred due to tax cuts, but the Joint Committee on Taxation states that it would result in the debt increasing by more than a trillion dollars.

Kent Smetters, Wharton professor of business economics and public policy, believes that trickle-down economics is nothing but a way to disparage supply side economics. In fact, he even states that “this is not something we have tested or seriously theorized about as economists.”

Similarly, according to popular financial website, Investopedia, “Trickle-down economics is political, not scientific. Although it is commonly associated with supply-side economics, there is no single comprehensive economic policy identified as trickle-down economics. Any policy can be considered “trickle-down” if the following are true: First, a principal mechanism of the policy disproportionately benefits wealthy businesses and individuals in the short run. Second, the policy is designed to boost standards of living for all individuals in the long run.”

More recently, a 2020 study by the London School of Economics that studied data over 50 years from 18 countries found that the only significant effect of Trickle-Down Economics was that it created further income inequality.

This is also evidenced by the fact that income inequality worsened between 1979 and 2005 due to tax cuts by US presidents Reagan and Bush and after-tax household income rose 6% for the bottom fifth. What is wrong with that, you ask? After all, an increase in income levels is good for everyone, isn’t it?

And I agree with you, dear reader. ‘Money makes the world go round’, as Joel Grey and Liza Minnelli sang, and more money is always helpful.

But this isn’t true if the top 20% see their incomes increase by 80%, and the top 1% see their income triple. Instead of the money trickling down, it seems that it trickled up- leaving behind nothing but a barren wasteland for the poor while the rich frolic in their paradise fuelled by the hard work of said poor.

It is thus reasonable to assume that Trickle-Down Economics is nothing but a load of hogwash. It seems as if those who support this theory forget that selfishness is a trait intrinsic to an unfortunate number of humans, especially those in power. Pope Francis himself said it best in his third Encyclical, “Fratelli Tutti”, on 4th October, 2020: “Some people continue to defend trickle-down theories which assume that economic growth, encouraged by a free market, will inevitably succeed in bringing about greater justice and inclusiveness in the world. This opinion, which has never been confirmed by facts, expresses a crude and naive trust in the goodness of those wielding economic power and in the sacralised workings of the prevailing economic system.”

Yet, the Indian Government led by Narendra Modi in 2019 decided to cut corporate taxes to 22% from 30% and to 15% from 25% for new manufacturing companies- this took place less than 40 hours before Modi’s Houston trip.

According to Modi, “This move will give a great stimulus to #MakeInIndia, attract private investment from across the globe, improve competitiveness of our private sector, create more jobs and result in a win-win for 130 crore Indians.”

Of course, many people genuinely believed this. However, this move, which resulted in a loss of nearly Rs. 1.5 lakh crore through direct tax revenue for the government, has done little to stimulate the economy and increase FDI.

In FY 2019, India received about 50 billion USD through FDI, but a sizeable amount of it was made before the move by Modi. Thus, it is clear that the tax cuts did little except increase income inequality (as expected, by most familiar with the nature of Reaganomics and by extension, its derivatives).

Even the GDP dipped a few points, before COVID struck. Moreover, the unemployment rate didn’t increase or decrease by a massive amount, which was what most people would probably expect from such massive indirect expenditures meant to, in part, fight unemployment. Of course, this is all being said without considering the pandemic and its effects on the economy. No one can be blamed for the problems it posed since it was beyond our control.

If the government had not taken such a bold step all the way back in September, 2019, it would’ve had more money to give to the poor. More money to help fight the pandemic. I’m sure that all of us would rather pay higher taxes and receive benefits from the government in return, than have the rich getting richer, and the poor getting poorer.

18 Comments

    1. Articulately worded and explained in very simple manner for all to understand.. Insightful and thought provoking..super effort

      Liked by 1 person

  1. Wonderful views.
    It is true that tax cuts below a certain low, decreases revenue instead. Cuts worked during Reagan’s presidency because the highest tax rate was 70%. They have a much weaker effect when tax rates are below 50%.
    Tax regiemes have varied effect on the stages of development of a nation. Apropos, tax models to ‘generate’ economic activity need low tax enticement to invest in business, specially the manufacturing sector. Conversly, a developed economy like the USA may need ‘sustainance’ tax incencentive model . Modinomics and Reaganomics, therefore, may be similar as a policy, but, are totally different in its effect on the economic phenomenon of the two types ; developing and developed economies.
    Nice article.

    Liked by 1 person

  2. Excellent! very creative work. Thanks for doing an excellent research and sharing your thoughts.
    Economist John Kenneth Galbraith once dubbed the trickle down economics the “horse and sparrow” theory: “If you feed the horse enough oats, some will pass through to the road for the sparrows.”
    Is build up economics an alternative? What do you say Viraj?

    Liked by 1 person

    1. Definitely! While of course, it can’t be the ultimate solution, it would go a long way in combating economic inequality and other issues. This pandemic itself is a testament to the fact that the richest will move forward, gaining more and more wealth at the expense of the rest of the world. The poorest need to be supported first and foremost- primarily through infrastructure creation which will lead to employment generation, income gains, etc. Even providing stimulus packages and subsidies can serve as a short term solution but in the end, we need something lasting to make an impact. Subsidies can be unsustainable too- more and more farmers in the nation are growing wheat/rice due to the MSP they get, which is hurting the environment and is affecting the growth of other crops. Apart from the poor, the educated middle class should also receive support from the government through job creation and control of inflation. So, in a way, build up economics is the way to go. Levying high taxes on the extremely wealthy to support human society is, in my opinion, a step forward in the right direction.

      Like

      1. Thanks for the explanation. Indeed, we have seen rich becoming far richer during the pandemic – stock markets have been hitting record highs, there have been more IPO’s this year than in the last 20 years, property rates have soared (at least in North America) and crypto’s have had a crazy run. Yet an average man has been hit by joblessness and now inflation. I agree that not only should the rich be taxed more (tax rates are historically low) but they should also invest in the public’s long-term well-being.

        Liked by 1 person

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