‘Trickle-down economics’ or sometimes known as ‘Trickle down theory’ was a term devised the US Democratic party as a way to describe a form of taxation that was introduced by Reagan. This tax strategy involves cutting taxes on the wealthiest in society. By cutting taxes on the higher incomes, governments hope that; investors buy more stocks and companies and business owners grow their businesses and employ more people. Eventually, when these wages “trickle down” to the middle and lower class they spend more causing an increase in aggregate demand and economic growth.
There are a few fundamental issues with this tax policy. Firstly, the notion that the wealthiest of society will spend all the extra money is completely false. According to the Business Insider, the top 1% of wealthy people have an average savings rate of 51.2%, whereas, the 2nd quintile saves only 0.09% of their wealth. This is because lower class families need to spend more of their incomes to be able to afford necessities. So in reality when providing tax cuts to the rich only a portion of that will be reinvested into the economy. This tax policy also works on the assumption that the wealthiest of people will be willing to increase wages. If workers aren't more productive, then business owners will see it as a waste and irrational to increase wages. Instead, the tax cuts will only maximize their profits.
The driving force behind economies is the middle class as said by John Maynard Keynes. This idea is called middle-out economics and supports the notion that the whole economy benefits from a thriving middle-class. The truth that businessmen create jobs during tax cuts is false. They create jobs when the middle class is thriving. This was best described by Nick Hanauer, American venture capitalist, as job creating comes from an “ecosystemic feedback loop animated by middle-class consumers.”
This means that businessmen will not create new jobs without demand from middle-class consumers. Warren Buffet further develops this, “I have worked with investors for 60 years, and I have yet to see anyone… shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes has never scared them off” So what this confirms is tax cuts don’t lead to jobs. Businessmen will create jobs if it’s a worthwhile investment and not if taxes are low. This is backed up by job creation statistics in the US. According to the federal reserve economic database, Bill Clinton created approximately 22.7 million jobs while increasing taxes on the rich and investing in the middle class. During the Bush administration, taxes were cut on the top 1% and job creation fell to 1.09 million jobs. Unemployment also rose from 4.00% to 7.8% during his time. Trickle down does not create jobs.
Trickle-down economics has left the US with a large problem known as income inequality and as a result a weak middle class. Between 1979 and 2005, household income for the bottom fifth of earners increased by 6% which sounds well and good, but when compared with an increase in 80% for the top fifth the poor actually got poorer in relation. In fact, the weekly wage in real terms have fallen since 1979 for the bottom 10%. This has left the bottom earning American with lower living standards and in worse condition than before ‘Trickle down’.
Trickle-down has many fundamental problems and works on many assumptions. Rich people have much higher savings rate meaning the tax cuts will remain in their pockets. Rich people also do not create jobs; rather the middle class is the driving force of the economy as described by ‘middle-out economics’. Trickle down has also left the US with large income inequality which was the opposite of what was intended. In conclusion, wealth does not trickle down; instead, it remains at the top and leaves the working class with less wealth which in turn leads to slower economic growth.
Written by: Rayyan Versi
Published on September 11th 2016