Wednesday, September 12, 2012

trickle down economics

"Trickle-down economics" and "the trickle-down theory" are terms in United States politics to refer to the idea that tax breaks or other economic benefits provided by government to businesses and the wealthy will benefit poorer members of society by improving the economy as a whole.] The term has been attributed to humorist Will Rogers, who said during the Great Depression that "money was all appropriated for the top in hopes that it would trickle down to the needy." The term is mostly used ironically or as pejorative

Economist Thomas Sowell has written that the actual path of money in a private enterprise economy is quite the opposite of that claimed by people who refer to the trickle-down theory. He noted that money invested in new business ventures is first paid out to employees, suppliers, and contractors. Only some time later, if the business is profitable, does money return to the business owners—but in the absence of a profit motive, which is reduced in the aggregate by a raise in marginal tax rates in the upper tiers, this activity does not occur.

Proponents of Keynesian economics and related theories often criticize tax rate cuts for the wealthy as being "trickle down," arguing tax cuts directly targeting those with less income would be more economically stimulative. Keynesians generally argue for broad fiscal policies that are directed across the entire economy, not toward one specific group.

In the 1992 presidential election, Independent candidate Ross Perot called trickle-down economics "political voodoo."

In New Zealand, Labour Party MP Damien O'Connor has, in the Labour Party campaign launch video for the 2011 general election, called trickle-down economics "the rich pissing on the poor".

A 2012 study by the Tax Justice Network indicates that wealth of the super-rich does not trickle down to improve the economy, but tends to be amassed and sheltered in tax havens with a negative effect on the tax bases of the home economy.


During the Reagan Administration it seemed that trickle-down economics worked. Reagan cut taxes significantly -- the top tax rate fell from 70% (for those earning $108,000+) to 28% (for anyone with an income of $18,500 or more). The corporate tax rate was also cut, from 48% to 34%. Reaganomics was successful in ending the 1980 recession. This was amazing, since the recession was marked by both double-digit unemployment and inflation, a dreadful situation known as stagflation.

However, it's difficult to say whether trickle-down economics was the only reason for the prosperity. That's because, while Reagan cut taxes, he also increased government spending -- by 2.5% a year. Reagan nearly tripled the Federal debt, which went from $997 billion in 1981 to $2.85 trillion in 1989. This spending went primarily to defense, in support of Reagan's successful efforts to end the Cold War and bring down the Soviet Union. Therefore, trickle-down economics was never really tested, since government spending is also a spur to economic growth.

To end the 2001 recession, President George W. Bush cut income taxes with JGTRRA, which ended the recession by November of that year. However, unemployment rose to 6%, so Bush cut business taxes with (EGTRRA) in 2003.

Apparently, the tax cuts worked. On the other hand, the Federal Reserve lowered the Fed funds rate from 6% to 1% during this same time period. Just like during the Reagan Administration, it's unclear whether tax cuts, or another stimulus, were what worked.

If trickle-down economics worked, then lower tax rates during the Reagan Revolution should have increased the lowest income levels. In fact, the exact opposite has occurred. Income inequality has worsened. Between 1979 and 2005, after-tax household income rose 6% for the bottom fifth of income earners. That sounds great, until you see what happened for the top fifth -- an 80% increase in income. The top 1% saw their income triple. Instead trickling down, it appears that prosperity trickled up!


Helping to clinch his eventual victory, Barack Obama declared in a 2008 presidential campaign ad, "The old trickle-down theory has failed us" [source: Yo­uTube]. This statement and Obama's victory resound like a death knell to an economic mentality that some say served to line the pockets of the rich. However, the trickle-down theory to which he refers remains a highly controversial topic. That Obama seeks to end trickle-down policy is certain, but what the theory really suggests and whether it has succeeded have been less clear.

Why do trickle-down economists think that taxing the wealthy less leads to an increase in production? That can be explained in terms of tax revenue. Some argue that giving tax breaks to the wealthy can actually increase tax revenue for a government. This might seem difficult to believe, but Arthur Laffer argued otherwise. Working off ideas posed by 14th-century Muslim philosopher Ibn Khaldun and John Maynard Keynes, Laffer concluded that government tax rates and revenues don't have a directly positive correlation.

In what became known as the Laffer Curve, Laffer showed that the relationship between taxes and revenues looks like a curve rather than a straight line. In other words, tax revenues don't rise consistently like tax rates do (which would look like a straight, positive correlation). Laffer's curve shows that when tax rates are at zero, revenues are zero as well -- the government makes no money when it taxes nothing. But it's the same result if the tax rate were 100 percent. Think about what would happen if the government demanded every cent in your paycheck. Why work -- or why tell the government what you're making? The government would bring in no money because there'd be no incentive to work or to report earnings.

So tax revenues are zero when the tax rates are at zero and 100 percent -- most agree about that. The question is, what does it look like between these extremes? The Laffer Curve postulates that once the rates get too high, the steep taxes discourage work to an extent that the revenues themselves suffer. Take another scenario: By June, you've already made a million dollars, and the progressive tax system promised to tax that income 50 percent. However, anything you make over a million will be taxed 90 percent. Why work the rest of the year when you know you can only keep 10 percent of your income? You'd probably take your half a million and retire to your beach house until next year. At this point, the taxes are discouraging work and tax revenue.

The range in which taxes are too high for maximum revenues is called the prohibitive range. When taxes are in the prohibitive range, a tax cut would produce an increase in tax revenues, according to Laffer [source: Laffer]. But the ideal tax isn't necessarily 50 percent; rather, it depends on the taxpayers [source: Wanniski].

Through Laffer's Curve, we can visualize how tax rates could discourage people from producing, which results in fewer jobs and a hurting economy. On the flip side, lowering taxes at the right time can reverse these effects. Laffer points to examples in U.S. history where lowering high tax rates increased not only government revenue, but also increased gross domestic product (GDP) growth and lowered the unemployment rate [source: Laffer].

The first instance of supply-side economics being implemented came even before the trickle-down idea was fully articulated. After World War I, top income tax rates had risen from a modest 7 percent to 77 percent to help pay for the war. This high rate would fall into the prohibitive range of the Laffer Curve, according to the theory. The Harding and Coolidge administrations passed a series of tax cuts to reduce wealthy citizens' tax burden, which had ballooned. Although opponents argue that this kind of policy contributed to the Great Depression, Arthur Laffer points to the resulting increases in tax revenue, gross domestic product (GDP) and employment as evidence that the tax cuts worked by boosting production [source: Laffer].

But this policy soon faced sharp criticism. When the stock market crashed in 1929 and the U.S. economy sank into the Great Depression, the idea of giving tax breaks to the wealthy was an unpopular policy. People blamed Herbert Hoover, who'd shown support for the tax policies of his predecessors. In 1932, voters replaced him with Franklin Roosevelt, who promised the New Deal that would help the economy from the bottom up. Keynesian economics took hold.

Wealthy members of society who'd enjoyed the low marginal tax rates of the 1920s would see a dramatic reversal in the next 20 years. During the Depression and World War II, the top marginal rate rose to more than 90 percent [source: Laffer]. Enter John F. Kennedy, who was sympathetic to the idea behind supply-side economics (recall his "rising tide" comment). He argued that lowering taxes increases tax revenue, creates jobs and increases profits [source: Nugent]. His tax cuts didn't pass until after he was assassinated, but Laffer argues that they had the positive effect on the economy that Kennedy had hoped for. Others say that the cuts hurt the gross national product (GNP) growth and resulted in rising unemployment [source: Friedman].


So from all this, I conclude it could work as the Laffer Curve concept makes sense to me.  The question is what tax rate to set and not to just reflexively raise or lower taxes.  And how do you know if it's effective (how long to wait for the results)?  Whatever they're doing it ain't working because it appears the middle class ain't getting richer.  We're just getting more dead money at the top.

It kind of makes sense to me to raise taxes in times of war (to pay for the war).  And lower taxes in times of peace.  Kind of the opposite of what Bush did and what Obama wants to do with the (hopefully) ending of war.

1 comment:

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