What is the Trickle-Down Theory of Economics?
Trickle-down theory or Trickle-Down Economics or Trickle-Down Effect is the belief that applying special tax cuts to the rich and wealthy as well as bigger corporations will benefit society by stimulating economic growth which will later affect everyone else. The trickle-down effect is tangentially related to the trickle-down theory of economics, which posits that rewarding the wealthy or businesses with tax cuts will stimulate the economy and benefit society. The assumption of this theory is that all members of society benefit from higher economic growth. Trickle-down theory is closely related to general principles of supply-side economics, such as Reaganomics, which called for widespread tax cuts, decreased social spending, and deregulation.
Benefits of the Trickle-Down Theory
- The theory claims that if the rich get richer, then so will everyone else.: Trickle-down economics postulates that applying special tax cuts to the rich and wealthy as well as bigger corporations will benefit society by creating economic growth. The increased income and wealth of high-income earners will filter down to all sections of society, leading to an increase in overall prosperity for everyone.
- If the rich get richer, they will spend more money and help the economy: When the richest gain an increase in wealth, they will spend a proportion of this extra wealth. This increases demand for goods and services, leading to higher employment and wages. The increased spending stimulates economic activity leading to a rise in tax revenues (higher income tax, higher VAT). This allows governments to fund public programs such as healthcare, education, and welfare payments to the poor.
- If the rich get richer, they will invest more money and create more jobs: If the rich gain an increase in wealth, they will spend a proportion of this extra wealth. This extra wealth will cause an increased demand for goods and services, leading to higher employment and rising wages. The increased incentive to work caused by lower income tax encourages people to work longer; lower corporation tax encourages business investments which create new jobs and increase the incomes of those employed; higher spending and investment stimulate economic activity leading to higher tax revenues which can fund public programs such as healthcare, education, and welfare payments to the poor.
- If the rich get richer, they will pay more taxes, which will bring more revenue to the government: When the owners of capital have more money due to tax cuts, they can invest in new businesses or scale up existing operations. This stimulates economic activity and leads to increased tax revenues from higher income tax and sales tax. The government is able to collect more taxes as a result of expanding economic growth, which compensates for any lost revenue due to reduced taxes on the rich and owners of capital.
- The rich can help the poor, by giving them money or hiring them: Giving money or hiring the poor can help them by providing an opportunity to earn an income. This extra income allows them to purchase goods and services, stimulating economic activity that creates jobs and raises wages. Additionally, investing in new businesses creates new jobs while investments in company stocks and bonds can lead to expansions or capital goods investments that provide more jobs for those employed. Furthermore, higher tax revenues from increased spending or investment can be used to fund public programs such as healthcare, education, and welfare payments for the poor.
- If the rich get richer, they will be able to afford better services, which will improve quality of life: If the richest gain an increase in wealth, they will spend a proportion of this extra wealth. This will cause an increased demand for goods and services, leading to higher employment and wages. The higher wages will have a multiplier effect as more people are able to spend their money locally on businesses. Additionally, investments made by the wealthy can stimulate economic activity leading to an overall rise in tax revenues which can fund public programs such as healthcare, education, and welfare payments to the poor.
- The rich have more knowledge and expertise, which can help them make better decisions for their businesses and the economy: The rich have more knowledge and expertise than the lower middle class, which helps them make better decisions for their businesses and the economy. Their knowledge and expertise allow them to make informed decisions that can benefit their businesses in the long term. For example, they may be able to spot opportunities for expansion or invest in capital goods that will encourage higher output in the economy. Additionally, they may be able to spot market trends or changes in legislation that could affect their business operations. This knowledge allows them to make better decisions that will ultimately benefit themselves as well as others in society.
- If the rich get richer, they will be able to give more to charity, which will help those in need: When the richest gain an increase in wealth, they will spend a proportion of this extra wealth which causes an increased demand for goods and services, higher employment, and a rise in wages. The trickle-down effect helps those in need by providing them with better access to healthcare, education, and welfare payments. It also stimulates economic activity leading to increased tax revenues that can fund these programs.
- The theory claims that when the rich get richer, they will share their wealth and prosperity with everyone else: Trickle-down economics suggests that benefits for the wealthy will trickle down to everyone else in the economy. These benefits include tax cuts for dividends, capital gains, high-income earners, and businesses.
According to this theory, company owners, savers, and investors will use any extra cash from tax cuts to expand their businesses. This expansion will create jobs for the working class who will then be able to spend their wages on goods and services produced by these expanding businesses. This increased demand should lead to economic growth across all sections of society.
Disadvantages of the Trickle-Down Effect
- The theory has not been proven to work: No, the theory of trickle-down economics has not been proven to work. In fact, it has repeatedly failed since its inception in the 1980s. Reagan's tax cuts and deregulation at the start of that decade did not lead to rapid growth; instead, they fueled a temporary boom that ended in a fierce recession. Furthermore, Donald Trump's recent tax cut never trickled down – instead, it benefited wealthy Americans while increasing the national debt and widening inequality across society. Similarly in Britain, after Thatcher's policies were implemented, social progress on many fronts has declined over the past decade despite economic growth – indicating that trickle-down economics is not working as promised by its proponents.
- Redistribution of wealth is not effective: The success of trickle-down economic policies has come under fire from several studies, which have shown that over five decades of tax cuts in 18 wealthy nations, the policies consistently benefited the wealthy but had no meaningful effect on unemployment or economic growth. Additionally, a study by the Rand corporation showed that decades of trickle-down policies in the US redistributed about $50 trillion in wage growth from the bottom 90% of earners to the top 1%. Furthermore, a report by the IMF found that increasing the income share of the poor and middle class actually increases economic growth while increasing the income share for the top 20% results in lower growth. Therefore it can be concluded that trickle-down economics does not work with redistribution of wealth since it only benefits those who are already rich rather than helping everyone equally.
- It benefits only the wealthy: The trickle-down effect is a theory that states that when the wealthiest members of society are given tax cuts or other economic benefits, their increased wealth will "trickle down" to the middle and lower classes in the form of job creation, higher wages, and increased economic activity. The reality is that this rarely happens in practice. Instead, most of the benefits tend to go straight into the pockets of those at the top who can use their newfound wealth for personal gains rather than investing it back into society. This leads to an increase in income inequality between those at the top who are benefitting from trickle-down economics and those at the bottom who are being left behind.
- It leads to economic stagnation: The trickle-down effect is an economic theory that suggests cutting taxes for high-income earners will lead to increased investment and job creation, which will in turn boost overall economic growth. However, economic analysis has shown that the trickle-down effect can have negative consequences. It can exacerbate income inequality by allowing wealthy individuals to accumulate more capital while middle and lower-class people lose out on their own slices of the pie. It can also incentivize greedy behavior as corporations retain money instead of reinvesting it into research and development (R&D) or labor improvements. Finally, policymakers may find it difficult to reverse course if trickle-down policies fail because raising taxes would be politically unpalatable for most parties involved in crafting real-world policy decisions.
- It increases income inequality: The trickle-down effect is the belief that when wealthy individuals receive tax cuts, they will invest their extra income in businesses and create jobs that will trickle down to low-income workers. This belief has been disputed by many economists, who argue that increased income inequality can lead to this inequality being solidified through educational opportunities, wealth accumulation, and the growth of monopoly/monopsony power. Furthermore, increased inequality may lead to lower rates of economic growth.
- It decreases government revenue: The trickle-down effect is the theory that cutting taxes for the wealthy will stimulate economic growth, resulting in increased government revenue. When applied at the federal or state level, this policy has met with disastrous results as it has not resulted in enough economic growth to offset lost revenue. Additionally, when applied at the national level it can lead to decreased government spending on programs such as education due to reduced revenues.
- It decreases demand and investment: The trickle-down effect theory states that cutting taxes for the wealthy and corporations will stimulate economic growth by increasing their spending and investment. However, this theory ignores the role of consumption and fails to consider how reducing taxes for the rich may increase budget deficit pressure. Furthermore, it does not take into account that some of the wealthy who receive tax cuts may not be as entrepreneurial or create jobs as expected. Ultimately, this leads to decreased demand and investment in an economy.
- It decreases employment: The trickle-down effect is the theory that lower taxes for the richest individuals and corporations will lead to more investment, more jobs, and higher economic growth. However, research has shown that this does not always hold true. When the top tax rate falls below a certain point, job creation does not increase enough to offset lost revenue from lower taxes. This is illustrated by the correlation between unemployment rates and top tax rates over time in the above graph.
- It creates economic instability: The trickle-down effect is the belief that cutting taxes for high-income earners and corporations will lead to higher growth and more jobs. It is based on the assumption that wealthy individuals and corporations will use their extra income to invest in productive activities, such as research and development (R&D), which will benefit everyone in the long run. However, this has been proven wrong by several studies which have shown no clear correlation between tax cuts for high earners or corporations and economic growth. In fact, some studies have found that increasing income inequality can actually lead to lower rates of growth due to decreased investment in educational opportunities for low-income workers. Furthermore, since policymakers may be reluctant to reverse course if trickle-down policies don't live up to expectations due to political backlash from raising taxes on wealthy taxpayers again, it can lead to economic instability if not addressed quickly enough.
- It leads to an increase in the deficit: The trickle-down effect is the belief that cutting taxes for high-income earners will lead to an increase in economic growth, which will then lead to increased tax revenues and reduce the budget deficit. The effect of this belief is that it can lead to an increase in the deficit as it fails to deliver on its promise of higher growth rates and lost revenue from reduced taxes. In fact, several studies have found that tax cuts for high earners have no clear impact on economic growth. Additionally, wealth accumulation by high-income earners may result in further capital gains and income from assets – leading to even higher levels of income and wealth inequality.
How Trickle-Down Economics Affects Businesses
Trickle-down economics encourages economic growth by relaxing economic policies that benefit wealthy individuals, such as investors and entrepreneurs. These policies include withholding capital gains tax, company net income tax relief, reducing tax rates for the wealthy, loosening regulations for businesses, and reducing capital gains taxes. Proponents of trickle-down economics argue that these relaxations will encourage the rich and owners of capital to stimulate economic growth through new business development and job creation. Over time this should lead to an increase in employment rates across industries due to increased company investment resulting from relaxed regulations and tax cuts.