The Myth of “Trickle-Down” Economics – Why Don’t They Work?

Whether or not you follow politics, you may have heard the phrase “trickle-down” economics before. Maybe it was in your social studies class, or on the 660 News radio one morning. Just in case you aren’t too clear with the term, trickle-down economics essentially refers to policies that funnel wealth into people who already have quite a bit of wealth (the richer portions of society). By doing so, these wealthy individuals who hold the means of production can invest in their own capital and decrease the prices of products for consumers. Everything would be cheaper, consumers could spend less for more, and ultimately everyone will benefit. Sounds like a pretty good idea, right?

Unfortunately, trickle-down economics are a myth. They don’t work.

But before the explanation of “why”, we can do some more exploration into the concept’s background.

In the 1980s, trickle-down economics was heavily promoted by U.S. President Ronald Reagan. His office used the official term of “supply-side” economics, while political opponents opted for terms such as “Reaganomics” or “voodoo economics” to enhance their criticism. “Trickle-down” also started as one of these terms, referring to the idea that wealth, after being spread at the top of society, would eventually “trickle it’s way down” through the rest of society.

Reagan’s policy involved tax cuts on businesses, high-income individuals, and capital gains. With a tax reform act, passed by Congress in 1986, Reagan lowered the highest income tax rate (for the wealthiest individuals) from 50% to 28% and increased the lowest tax rate from 11% to 15%. Reagan kept his policies for his term, but the results weren’t exactly fantastic. Economic growth in the US was stimulated, and unemployment rates did decrease. However, at the same time, the public debt practically tripled from $712 billion in 1980 to $2.05 trillion in 1988. Additionally, economists today will argue that the limited benefits of Reaganomics came solely from increased government spending, averaging 22.4% of the GDP during Reagan’s term, which was well above the ~20% average from 1970-2010. These economists would tell you that it was Reagan’s increased spending that stimulated the economy, rather than his policies of tax cuts to trickle-down wealth.

So all of this would continue to beg the question “why don’t these trickle-down policies work?”

The answer is twofold.

Firstly, I want to go back to an earlier term I mentioned: “supply-side economics”. Trickle-down policies don’t work because supply-side policies don’t work.

What do I mean by this? Most of you will remember the ideas of supply and demand from Social Studies. As demand for a certain product increases, and more and more people want to buy said product, businesses and individuals with the means of production will invest in their capital in order to meet this demand. This would include job creation, like building more factories to make the product, or spending more on existing assets, like buying better machines for your current factories. Similarly, if demand for a certain product decreases, businesses will invest less into their capital.

This is the idea that would drive supply-side policies, which puts more resources into the “supply side” of the supply and demand balance. These policies hope that more money to the rich will lead them to invest in their capital, so they can increase jobs and improve production, lower prices, and spread the wealth.

Except that isn’t how supply and demand works. Artificially inflating supply does not also inflate demand. A business will not randomly begin building more factories just because they have the money to do so. They would only build more factories if they need them because demand is high. As a result, when trickle-down policies are established, none of the job creation or economic growth actually happens.

The second reason trickle-down economics don’t work is because, just in general, people are greedy.

As we’ve established, rich people and rich businesses, as they get richer, will not invest that money into their capital. Rather, they invest it in the stock market or real estate, or stash it in a tax-free haven outside of the United States under the radar. Either that, or they can just spend their money on luxuries like foreign travel, sports cars, yachts, or other extravagant items. Why not? There are no regulations in place that state exactly how a person is required to spend their money. If a middle-class individual is able to buy a car or take a vacation, then a rich individual can do the same, multiplied tenfold.

When trickle-down policies offer more money to the wealthy, the wealthy simply see more opportunities to improve their own lives. Unfortunate as it may be, we can’t assume that people will want to share prosperity and wealth when there is no incentive for them to do so. But instead of taking my word for it, we can also look at the statistics. It has now been over 30 years since Reagan introduced the idea of trickle-down economics, and for the longest time, it has remained a driving economic theory. And yet, the wealth gap in the US continues to grow every day, to the point where the richest 1% owns more income than the combined bottom 90%. Additionally, the richest 8 people in the world, 6 of them being Americans, are worth as much as half the human race.

Once you realize that trickle-down economics does not work, you will see the excessive tax cuts for the rich as what they are – a simple upward redistribution of income, rather than a way to make all of us richer, as we were told.

-Ha-Joon Chang, South Korean economist

Furthermore, in 2015, the IMF (International Monetary Fund, an impartial organization built to promote global monetary cooperation) released a report arguing that there is no trickle-down effect as wealth is funnelled into the richest of society. In an analysis of over 150 countries, it was calculated that for every 1% more income the richest 20% of society made, the annual rate of economic growth would decline by 0.1%. Conversely, for every 1% more income the lowest earners of society make, the annual rate of economic growth would increase by 0.4% over the same period.

In light of all this, I would say that ultimately, it makes far more sense to “build up” an economy, than it does to “trickle one down.”

But the reason that trickle-down economics are becoming relevant again today is because Donald Trump is now the President of the United States. You may be sick of hearing his name by now, and I wouldn’t blame you. But hear me out on this one. His economic policy is one of trickle-down economics, and he plans to cut the top marginal business tax rate from %35 to %20. On top of that, he has proposed a “tax holiday” for corporations to stash earnings overseas at a mere 10% tax rate. And on top of that, he is cutting taxes across the board, but the overwhelming majority of cuts will go to the highest-income households.

It’s quite concerning that outdated economic policy, proved to be ineffective, is still somehow in use today.

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