Trickle down economics is a term used to describe the belief that if high income earners gain an increase in salary, then everyone in the economy will benefit as their increased income and wealth filter through to all sections in society.
However others criticise this belief that if the top earners in society gain an increase in income, everyone benefits as a result. Some studies suggest 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.
A recent report by the OECD found that since the start of the credit crisis in 2008, inequality has widened in many countries; however this inequality has led to lower rates of economic growth not higher.
This graph from an OECD report suggests that inequality is responsible for lower GDP. The OECD estimates that the UK economy would have been more than 20% bigger had the gap between rich and poor not widened since the 1980s.
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 high-earners, but also everyone. The argument is as follows:
- 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.
- Alternatively, increased profits for firms may be reinvested into expanding output. This again leads to higher growth, wages and incomes for all.
- Lower income taxes increase the incentive to for people to work leading to higher productivity and economic growth. Continue Reading →