What is Trickle Down Economics? Does it Work? Complete Guide

Trickle Down Economics

The theory of trickle-down economics states that the benefits of economic growth and expansion in a country trickle-down to the population. The model assumes that business owners and investors are the driving force behind an economy.

When their companies and assets produce a profit, the wealth “trickles-down,” from the shareholders to the executive management, then the employees, and finally the broader economy.

The government creates this financial stimulus for business by providing the private sector with tax cuts. Trickle-down economics assumes that, with more cash-flow available, business owners will expand their efforts and investors will buy more assets like stocks and bonds.

As a result, the additional economic activity at the top level trickles down into the broader economy. Owners expand the business, hiring more employees while increasing salaries for existing workers. The workers then take their new wage packets and spend them in the economy on goods and services, driving demand and growth in the local and national GDP.

Trickle-Down Economic Theory Explained

Similar to supply-side economic theory, trickle-down economics suggests that all tax cuts, regardless of whether they are for the private or public sector, will cause an increase in economic activity resulting in GDP growth.

Where trickle-down theory stands out from supply-side models, is in the fact that it states targeted tax cuts are more efficient at providing an economic stimulus than general tax cuts.

The trickle-down theory calls for the tax cuts to benefit corporations, for capital gains and savings. Therefore, it doesn’t support broad tax relief for employees, and the benefits of the policies go to the wealthy instead of the middle class or working class employees.

Arthur Laffer was the creator of the “Laffer curve,” which is the most persuasive evidence to support the case for those individuals who tout for both trickle-down and supply-side theory.

Laffer Curve

The Laffer Curve. Source

The curve shows how lowering taxes provides a potent multiplying effect on GDP, and the growth rate eventually results in the broader economy paying back the money the government lost through tax cuts by creating the environment for prosperity, and a more extensive tax base.

However, many modern trickle-down theorists fail to adhere to Laffer’s warning that this trickle-down effect only works when taxes are in the “prohibitive range,” meaning anywhere from a 100-percent tax rate to a rate around 50 percent.

Should the tax rate fall below this prohibitive range on Laffer’s curve, then any further tax cuts will fail to provide the necessary stimulus to pay the government back the money it loses on the cuts.

The History of Trickle-Down Economic Policy

President Ronald Reagan was the first to adopt a trickle-down economic policy in the 1980s, and for a while – it seemed like it was working. The administrations infamous monetary and fiscal policies, now known as, “Reaganomics,” was the driving force that helped pull the American economy out of recession.

Regan started by cutting taxes significantly, reducing the top tax bracket from 70-percent tax for those earning $108,000 or more to a staggering 28-percent. At the same time, Reagan cut the corporate tax rate by six percent from 46 to 40-percent, providing business with a significant stimulus.

However, the tax cuts were not the only factor for the economic miracle. Reagan decided to increase government spending to the tune of 2.5-percent each year, and in doing so – he successfully managed to balloon the Federal debt from $997-billion in 1981 to $2.85-trillion in 1989, nearly tripling the taxpayer debt load.

As is with most government spending nowadays, a large percentage of the funding went into military projects, including Reagan’s notorious, “space wars,” program.

Trickle Down Effect

The Trickkle Down Effect. Source

The Bush Era

With the popping of the “Dot-com bubble,” at the end of 1999-2000, the American economy found itself once again on the brink of disaster. The contagion effect from Japans Nikkei losing over 40-percent of its value overnight sent the world spinning out of control.

In 2001, President George W. Bush attempted to use trickle-down economics to put an end to the recession plaguing the country. Bush cut the income-tax rate yet again, introducing the “Economic Growth and Tax Relief Reconciliation Act.”

As a result, the recession abruptly came to an end by the November of that year, and a new bull market started that would see the American economy through to the start of the 2008 financial crises.

However, even due to the booming economic recovery, employment figures were lagging, showing a 6-percent unemployment rate. Any economist will tell you that it takes time for companies to recover from the effects of a recession, and they may delay hiring by a few quarters.

To curb the issue, Bush decided to give the employment sector a boost with the introduction of the “Jobs and Growth Tax Relief Reconciliation Act,” in 2003, while once again cutting corporate taxes for business owners.

According to trickle-down theory, the tax cuts should provide a financial incentive for all American citizens at all income levels. However, in practice, the opposite started to occur; as a result, the income gap widened.

While the lower-level employee found that they were taking home as much as an extra 6-percent a year on their salary, the top-earners gained a staggering 80-percent increase in their income. It would appear that the “trickle-up” economic effect was in play.

So, where did it all go wrong?

The Elephant in the Room

Before the turn of the new millennium, tax-cuts dominated trickle-down theory. However, starting with Reagan, a new tool in the trickle-down toolbox of financial weapons began to emerge.

Monetary and fiscal stimulus soon started to take precedence over tax cuts as the leading instrument used by the government in trickle-down theory. In the wake of the 2008 financial crisis that sent Lehman Brothers into bankruptcy seemingly overnight, the government stepped in with the help of the Federal Reserve, to arrange a stimulus package to bail out the banks – at the cost of the taxpayer.

What Caused the 2008 Financial Crisis

Read: The Great Recession

The Federal Reserve started up their printing press and created nearly $700-billion in loans to the investment and commercial banking sector to prevent them from going bankrupt. At the same time, the Fed saw fit to extend their balance sheet to nearly $4-trillion to compensate for any liquidity crises in the future.

The banks had a field day with this money. While handing out stimulus, the Fed reduced the interest rate to 0% for the first time in American history, giving the banks access to cash for “free.” The Fed mage agreements with the banks that they were to invest this money into new loans into the economy.

Instead of providing consumers with loans, the banks decided to use the money to create one of the largest bull-runs in modern stock market history, with the S&P 500 rising from 666-points at the end of the crash in 2008, to touching new highs approaching 3,000, some ten years later.

However, the public never saw a dime of prosperity from all of this stimulus, and instead, American consumers and blue-collar workers are more in debt than at any time in American history. The average millennial has no savings, and can’t afford to pay a $3,000 emergency medical bill.

While the American people are yet to see any prosperity from all of the fiscal and monetary stimulus created by the U.S government and the Federal Reserve, Wall Street is setting records for IPO’s, CEO bonuses, and employee compensation.

Remember the Regan administrations heroic praise for trickle-down economics ending the recession? Well, the argument remains that it was his aggressive government spending that ended the countries economic woes, not the tax cuts.

Malinvestment, Government Spending, and War

Along with tax cuts, and stimulus packages, the government has been hastily adding new tools to the trickle-down toolbox of economic mystery over the last few decades. The Regan administration paved the way for governments to create massive amounts of debt, using it to stimulate the economy.

However, Reagan had no idea of the trouble this would cause in future administrations. When policymakers realized they could print money and use it in their programs with no real damage to the economy, they ramped up their operations.

As a result, “the war on terror” emerged in the wake of the 9/11 catastrophe, and the Federal Budget allocated to the Pentagon began to inflate to astronomical levels.

A recent 2017 report shows that the Pentagon cannot account for nearly $7-trillion of spending in the last 20-years, that’s a staggering 33-percent of the national; debt, with no accounting behind the expenses.

While the massive budgets swell the bank accounts of shareholders in defense companies, such as Lockheed Martin and Raytheon, it does nothing to help the American people. Instead, this malinvestment in war spending is taking its toll on America.

Many States and counties throughout the United States are experiencing rapid deterioration of infrastructure. How can this be so, when the government is spending trillions on the military?

Why are water systems failing across the country, pension plans on the brink of collapse in many States, and some State coffers are starting to show the emerging signs of bankruptcy on their balance sheets.

The American people have never been in more debt than at any other point in the history of the nation. Consumers are tapped out on credit, so the government shifts the goal posts and adjusts FICO scores to allow already stretched consumers to tap new loans.

Medicare is a failing ambition of the previous administration, and it costs the country billions of dollars annually, and all the while the national debt has skyrocketed from $2.85-trillion at the end of 1989, to over $22-trillion as of Q1 2019. The Trump administration accounts for nearly $2-trillion alone over the last three years.

One thing is clear; there is no trickle-down effect to the American people, other than the promise of deeper government debts that the American people will have to pay off in the future.

Trickle-Down Economics in 2020

From the above examples, we can safely assume that the basic principle of trickle-down economics, namely tax cuts, is an abysmal failure at spurring economic growth. If it were not for changes in monetary and fiscal policy, along with excessive government spending and rising Federal debt levels, America might have never left the 1980s recession.

However, it seems that while this may make sense to just about anyone who reads this article, it looks like the current administration is somehow blissfully unaware of the issues with the theory. As a result, many political parties still use tax-cuts as their go-to incentive to acquire support and election from the American people.

President Donald Trump signed the “Tax Cuts and Jobs Act,” on December 22, 2017. This action reduced the corporate tax rate to 21-percent from 35-percent, starting in 2018. Along with this, Trump could not resist handing the top income earners a further cut, reducing it to 37-percent.

The trump administrations tax initiative cuts income-tax rates while doubling the standard deduction and eliminating personal exemptions. Trump stated that changes to the corporate rate are permanent, while individual tax rates will last until 2025.

As a result of these policies, research shows that the top 1-percent of earners receive more substantial cuts, while the lowest 20-percent of income earners would end up paying higher taxes by 2025.

With this policy, the government pulls the wool over the eyes of the public, making them think that they are receiving benefits in the early stages of the tax plan while being set up for pillaging by the government after the Trump administration leaves the Oval Office.

Wrapping Up – Failed Policy Mistakes Kill Capitalism

While it’s easy to see how the government uses the instruments of monetary and fiscal policy to stimulate the economy, it appears that the broader American public remains unaware of the real economic costs of these changes.

While most people will cheer to see a reduction in the taxes they pay, they fail to realize the real cost to the country over the decades ahead. With mounting government debt levels, and crumbling infrastructure across the country, it’s easy to see why polarizing figures like Democratic Representative, Alexandria Ocasio-Cortez, are starting to gain traction with their socialist policies.

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Oliver Dale is Editor-in-Chief of MoneyCheck and founder of Kooc Media Ltd, A UK-Based Online Publishing company. A Technology Entrepreneur with over 15 years of professional experience in Investing and UK Business. He built Money Check to bring the highest level of education about personal finance to the general public with clear and unbiased reporting.


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