Trickle Down Economics

Trickle down economics is a term used to describe policies which primarily benefit the wealth and high income earners. The term ‘trickle down effect’ is often used pejoratively – in that economists often criticise ‘trickle down policies’ which in effect do little to improve the welfare of the average citizen.

Trickle Down Effect and Tax Cuts

An important element of the trickle down effect is with regard to income tax cuts for the rich. It is argued that cutting income tax for the rich will not just benefit the rich, but also everyone. The argument goes as this:

1. If high income earners see an increase in disposable income, they will increase their spending and this creates additional Demand in the Economy. This higher level of Aggregate Demand creates jobs and higher wages for all workers.
2. Alternatively, increased profits for firms may be reinvested into expanding output. This again leads to higher growth, wages and incomes for all.

Criticisms of the Trickle Down Effect

• Rich have a high marginal propensity to save.
• Because money has diminishing returns. High income earners tend to save a high % of any tax cut. Therefore, little of the extra money will filter down into the rest of the economy.
• Higher GDP doesn’t address the fundamental inequality of Capitalist society. Even if tax cuts did lead to higher economic growth, higher output doesn’t address the fundamental inequities of Capitalist society. Most firms are not run to give workers a % of the profit. Therefore, higher output does not necessarily increase incomes, especially for the low skilled and part time workers.
• Budget Deficit. Cutting taxes in the US, led to an increase in the budget deficit. (from 2.7% of GDP in 1980 to 6% of GDP in 1983) Although, this provides a temporary fiscal boost, a budget deficit creates problems for the future economy (higher interest rates, higher taxes in the future)
• Wrong Target. If you want to reduce relative poverty, it makes sense to target income tax cuts and benefits at those who need it. Cutting taxes for the rich, in the hope some may trickle down to the poorest is a very inefficient way of working.
• Cutting taxes does not increase incentives to work.
• It was hoped cutting income tax would encourage people to work overtime and work more hours. But in practise, this didn’t occur.

Ronald Reagan and the Trickledown Effect

Ronald Reagan was closely associated with the trickledown effect in the 1980s. This is because during his presidential term, he cut income tax for the high earners. He did not sell this policy on the grounds that ‘there will be a trickle down effect.’ However, opponents often claimed that this miserable ‘trickle down effect’ summarised Reagan’s economic policy and disdain for reducing poverty.

G.W. Bush and Trickledown effect

The economic policy of George W. Bush closely mirrored that of Ronald Reagan. Faced with an economic downturn in 2001, he cut taxes; most of which were targeted at higher earners.