Trickle-down economics (TDE) refers to an economic theory that believes that special privileges provided to the rich and wealthy people will trickle down and benefit everyone in society. This theory has a lot of prominence and acceptance within society, academicians, government, intellectuals, policymakers, etc. We are here to look into what trickle-down economics is, how it works, and what the various problems associated with it. The problems are rarely covered very well in the popular discourse, and we are here to rectify that.
This idea stems from the fact that the rich and wealthy are money experts, and they know best how to handle and grow money. The theorists want the government to play the role of aiding the wealthy and rich through less regulation, lower taxes, investments, and more incentives. It is a form of political policy on the role of government in economics.
It comes under the bigger sub-branch of the Supply-Side economics, which calls for tax cuts. The experts here believe that the rich and wealthy will help them pour that money back into the system, which will result in more private investment, which will result in more jobs for the middle-class and poor, which paves the way for money for the families and enhanced spending power. The people then spend that money in the market, bringing more growth and development in the economy. Compared to the government, whose job is to govern, the experts believe that the government shouldn't meddle in the economic functioning of the country because it is not within its expertise and goes against the jurisprudence.
The phrase “trickle-down theory” was coined by Will Rogers during the 1932 election when US President Herbert Hoover failed to control the Great Depression. Contrary to what you may think, this theory was actually a criticism of trickle-down economics. He used to criticize economic policies that favoured the wealthy or privileged while being framed as good for the average citizen.
Later in the 1980s, the US President Ronald Reagan talked more about TDE economic policies, which people called it as Reaganomics. This was the first time TDE was actually adopted as a government policy by any government. His famous statements, such as the government is the problem went viral. The various successive US administrations have taken efforts to follow this line of economic policies. UK PM Margaret Thatcher followed a very similar approach.
Where does trickle-down economics differ from capitalism? Capitalism talks about private ownership and lower regulation, while the TDE goes one step forward, calling for government support for the private industry.
All theories come with a series of assumptions. Here also, we have a series of assumptions. Most importantly, we assume, wealthy individuals and corporations reinvest their earnings in multiple ways that benefit society. The second strong assumption is that reduced taxation on the wealthy stimulates economic growth and creates jobs. This is what is used by the supporters to argue in favour of this. Lastly, the benefit of economic gains for all, i.e., eventually improving living standards for all societal strata.
Policies of Trickle-Down Economics
Corporate income tax reduction, tax cuts for the wealthy, and deregulation are the various steps of a trickle-down economic policy. Given that the rich and corporations hold most of the money in the market, solutions begin with them.
American economist Arthur Laffer, a member of the Reagan administration, developed an inverted u-curve style analysis that plotted the relationship between changes in the official government tax rate and actual tax receipts, known as the Laffer Curve.
Taxation performs two functions: to earn money for the state/government, and to curtail inequality. TDE views taxation as a form of punishment for being rich (successful). Cutting down taxes would mean less money flowing to the government, which means less money to fund the infrastructure, policing, and maintenance of law and order. Here's a catch: businesses like to be in an area with good infrastructure and better law in order, but the same corporations don't want to pay for them. So who pays for the same? Usually, others.
Examining the assumptions and arguments in detail
"Wealthy individuals and corporations reinvest their earnings in multiple ways that benefit society". Yes, they do, but we assume that it will be for the idea of the greater good or for their concern for society and its people. This is the main problem. We see people as either good or bad, but in reality, there are shades of grey. Most businessmen and corporations reinvest, but it's for their own benefit, making profits and capturing. It is not because they are so much interested in charity.
There will be an increase in wages and salaries for the employees. Yes, they do create jobs, more opportunities, and benefits for the consumers. At the same time, their production houses, factories, etc., are located in areas with lower wages, less regulation, and looser labour laws. They are making more profits, but not adequately paying enough in proportion to their counterparts. For example, an Apple factory in India will definitely pay less for the same amount of work than an Apple factory in the USA. But the profit from that phone will be significantly higher.
"Lowering taxation will mean more money for reinvestment"
Corporations and businesses, when they mean low taxes, generally refer to low corporate taxes. Corporate tax is the tax on profit, and hence it is paid proportionally to the money they make. In short, yes, less taxes mean more money for reinvestment. The Laffer curve shows that there exists an optimal level of taxation, which is a win-win situation for both the govenment in the world.
But the question really is, do they actually reinvest or not? When the economy is booming, or the company sees a lot of demand in the market, yes, they reinvest, expand, and scale their business. But when the demand is weak, they don't; instead, give raises to their board members, management, and employees, give dividends to shareholders, etc. So, reinvestment due to lower taxes cannot be guaranteed as a universal truth.
"Lowering taxation will mean more money for workers"
As discussed before, corporations themselves decide what to do when there is a tax cut. There is no single answer we can conclude. Also, given that corporate tax is on the profit, paying employees or giving them a raise is seen as an expense for the company, which will actually bring down the profit of the company next time. Most economic studies show no link between low taxes and higher pay for employees or increased hiring.
Problems with Trickle-Down Economics
TDE failed to solve the same problems it intended to solve. The results of various economic indicators do show that the situation has not only not become better but also that these have made the economic problems worse.
Income Inequality
It remains one of the biggest economic problems faced by all countries. It is seen more in developing countries as well as a handful of developed countries. Why is income inequality bad? This is a good question, yes economics says some people win while some people will lose. Yes, but income inequality drags down the economic growth of a country. Imagine a country where 5 or 10% get all the advantages and the rest suffer. The consumption and contribution of the rest of the country economically paralyses the country. The masses are kept away from participating in the economy and benefiting from it. Is this the sign of a healthy economy? Income inequality also creates an environment of perpetual poverty, which affects generations. This inhibits their access to quality healthcare and education.
Socially speaking, the effects of the inequality are significantly more. It also proliferates both violent and property crimes. Politically, it's also bad for democracies. There will be the creation of an unequal distribution of power. Such events create distrust in the democratic fabric of the country. Important historic events, notably the French
Revolution and the events leading to the US Civil War, etc., were rooted in people taking economic inequality seriously. People's uprisings due to economic inequality in the twentieth and twenty-first centuries. The latest ones being in Sri Lanka, Nepal, and Bangladesh.
Politically speaking, politicians and policymakers only took action against income inequality, all
of this is only because of the protests and their regimes being in danger, nothing else. Also, the ability of rich and powerful people to influence elections and engage in corruption becomes more. We can take the example of Elon Musk and how he tried to influence the US Elections 2024 and sub-elections through his money and power. It is important that this is before him becoming a trillionaire.
Coming back to the topic of importance, discussed before, low taxes meant the rich paid less in taxes, making them richer and wealthier. The system is designed in such a way that the rich people already have the first-mover advantage. One of the biggest promises of TDE was that it would equally help people from the lower strata and the middle class, but that benefit was highly disproportional. The gap between the rich and the poor widened even though there was a benefit to everyone in the society.
In India, income inequality has increased in the past few decades. While India is one of the fastest-growing economies in the world, it is also one of the most unequal countries. As of 2022–23, the top 1% of Indians held about 40.1% of the country’s total wealth. The top 10% of the Indian population holds 77% of the total national wealth. As per TDE, the inequality should have actually reduced, but it has not. Healthcare and education are still out of reach for many.
Limited Job Creation
Unemployment is one of the most significant indicators of the economic health of a country. Most countries face high levels of unemployment, and the wages people receive are meagre. People assume that tax cuts mean companies are ready to pay more, but there is no clear evidence to show that happens. Corporations tend to prioritise profit maximisation rather than reinvestment in job creation or increasing wages.
The Stagnation of the middle and lower Classes has been a bigger cause of problems in the developed world, where there is more anger against the millionaires and billionaires in the developed world than in the developing world. This is largely because real wages for middle- and lower-income groups often remain stagnant despite strong GDP growth. The rising costs of living have broken these groups, putting them at a permanent disadvantage.
Economic Challenges
TDE calls for complete deregulation or full non-interference from any government, in an ideal situation. But we know we don't live in a perfect free market; hence, the government involvement exists, but the argument here is that markets know everything and they are always right. But there are situations that require external intervention, such as natural disasters, building infrastructure, and, in certain situations, such as irregularities that arise within the market.
Yes, we don't live in a 100% free market world, but rather a world with a mixed model. Even then, we have pro-free-marketers who argue for less government, but whenever a crisis comes, they expect the same governments to rescue the markets. Reliance purely on market dynamics can lead to speculative bubbles and financial instability. The 2008 global financial crisis is the best example of the same. Many experts blame it on deregulation and wealth concentration.
Hence, we cannot expect markets to correct themselves (always), rather we need a neutral government that will establish fair rules, not allow monopolies, and prevent hazardous events such as pollution without harming the population at large. At last, let's not forget that governments exist to protect the people and not the corporations.
Reduced Government Revenues
Duties of government have expanded beyond protection. Today, the government builds infrastructure, providing and maintaining public goods, and reducing (social, political, and economic) inequalities. All of this requires money, and the best way the government makes money is by collecting taxes. Without spending, infrastructure, and consumer confidence, no business will sustain. This is where we need governments to function well, and the best solution is taxes.
The tax cuts for the wealthy can lead to budget deficits and underfunded public services. We can see how the Reagan Adminstration who called for reducing government expenditure and bringing efficiency, left its office with significantly increased federal deficits, mostly because of the massive defense and military spending.
Weak Multiplier Effect
This phenomenon is nothing but a consequence of all the other factors. When tax cuts happen, the rich and wealthy tend to prevent that benefit from being transferred to others, notably the lower groups. One important factor that keeps the lower economic strata going is the multiplier effect. Saving more, or the lack of spending of the top 1% compared to lower-income groups, reduces the multiplier effect of tax cuts.
Regional and Sectoral Disparities
Based on the same assumptions that we understood, TDE is all about transferring the benefits or building a form of equity for all. But the majority of the benefits of a growing economy are often concentrated in urban, affluent, or high-growth sectors, neglecting rural and underdeveloped areas. This divide is not just in the developing countries but also in the developed countries.
The fallacy of expertise/Halo effect
Some really good businessmen want to contribute to society, and maybe people see that it's a good thing. Beyond doubt it is, but expecting them to be experts in charity just because they are experts in one field is appalling. This is where we expect them to solve all the problems we face, which is not right. If there are tax cuts, which means money in the hands of the wealthy and the corporations, do they solve the problems?
Elon Musk is the world's first trillionaire, and he has various companies under his leadership. When Twitter was acquired, he focused on that purely from a communication media perspective rather than on the sociological and psychological effects of his actions. The first action he took when he acquired Twitter for $44 B was to cut jobs in the name of efficiency. A similar issue happened with his Department of Government Efficiency (DOGE), where he tried to apply his business knowledge, trying to corporatise the functioning of the government. He fired many federal workers, and some of them had to be rehired. Public governance is not about maximising profits and reducing wastage; it is about stability and trust.
Society is complicated, and so are the problems. There are specialised and dedicated entities that work on such initiatives for a very long time. We cannot replace them with billionaires and millionaires. We need to pay equal heed to what the actual experts- the local community leaders, legal experts, and the social workers who worked for a very long time to be made equal participants here.
Case Studies
Reaganomics (1980s in the USA)
During his tenure as President made a key policy of slashing the top marginal income tax rate from 70% to 50% in 1981 and later down to 28% in 1986. The key understanding is that untaxing the wealthy would increase capital investments in the country. The actual result was that it initially helped in the economic growth, but there were significant increases in income inequality and federal debt. It has tripled the national debt from $997 B to $2.7T.
2000s Tax Cuts in the U.S.
It was a follow-up to the earlier tax cuts. The corporate tax rate has now dropped to 35%, and the taxes on capital gains and qualified dividends have fallen to 15%. The tax loss for the same is estimated at $1.7T. Under the Bush administration, the job creation was at just 45,000 compared to 237,000 per month in the 1990s. The actions of deregulation in the period further led to the 2008 Global Financial Crisis, which has put a permanent scar on the globalised world economy.
What are the alternatives to trickle-down economics, and how can we fix the situation?
Immediately, people will jump to the conclusion that the solution is to turn down and abandon capitalism, or the fans of capitalism will call me a socialist or communist. But we actually don't need to; rather, we can do minor tweaks within the current system. Here are the solutions to the problem.
Progressive Taxation
Here, we talk about taxation as a form of justice rather than taxation merely as a means to add more revenue. Who is taxed more, and who is taxed less, is discussed more here. All the studies have proven that the higher the percentage of indirect taxes in a society, the more it hurts the lower strata of the society. This is where the taxation system is reversed to make direct taxes more. This is what is followed in the Nordic Model. Despite high taxes, they still rank high on business-friendliness and global innovation. The taxes directly go to redistributive policies to fund public services and reduce inequality. These countries also rank high on social mobility.
Wealth Tax
Our income and other forms of liquid assets are taxed, but rarely is stagnant capital such as real estate. Taxing such stagnant assets can bring the money back into the market. It is not just for the flow of money but also for economic justice. Why should one inherit wealth and create more inequality without any fairness?
Targeted Fiscal Policies
Here, we follow a mix of demand and supply economics. The government takes the initiative to invest in healthcare, education, and infrastructure, which is aimed at spurring growth and creating demand in the market. Governmental spending generates the multiplier effect we discussed earlier. Along with that, we have direct governmental intervention in the market to help MSMEs and small businesses to have a level playing field against the big corporations. Along with that, we have strong regulations that ensure fair competition, preventing the creation of monopolies and oligopolies. Here, the financial incentives are for the smaller businesses and not for the rich and the wealthy. We must also hold the market responsible for their failures.
Strengthening Labour Rights
What is an industry without workers? They are the heart and soul of the industry; they keep it going. Even today, we have big complaints from the industry on labour shortage and the lack of skilled labour. This means that labour is still integral to any economy, not just the corporations. What do workers need? Fair wages, safe working conditions, a stress-free workplace, and job security. What the government should do is implement policies to ensure fair wages, support unionisation (as a mechanism to address their problems), prevent anything that destabilises the economy, and which may disadvantage the labour market. Can an economy sustain itself where workers don't get paid enough, and their rights are not protected?
Universal Basic Income (UBI)
Exploring income redistribution to ensure basic living standards for all citizens. In 2020 and 2021, Americans received $1200 stimulus checks who lost their jobs during the COVID-19 pandemic. It was done to stabilise the economy as well as protect the workers and their families. This is a Keynesian model. Now imagine that the government gives a fixed amount to everyone to cover their basic expenses, such as buying groceries, education, buying medicines, etc.
This is a solution that unites both left and right, Silicon Valley elites, as well as the left progressives. Why? Tech elites feel that, given that AI and automation will take away jobs, they need to keep society running. They see that the market's consumption shouldn't drop just because people don't earn enough. Libertarians support UBI, wanting the government to eliminate all welfare (corrupt) institutions and instead hand over direct cash to people. The left sees this as a move to eradicate poverty, provide dignity to everyone, and prevent people from engaging in anti-social activities and crimes. They all view this not just as a welfare measure but as an essential part of humanity.
Conclusion
Started as a policy to create the bedrock of neoliberal economics, generate more about consumption, and change the lives of people amidst various economic problems and challenges of the Cold War. Even though it gave a temporary relief from all the problems of the time, it later created widespread economic inequality and disparities, which will take years to fulfil.
The key problems of Trickle Down Economics include the proliferation of income inequality, low job growth, lack of governmental revenue, and regional and sectoral disparities. Overall, they create wider economic challenges and show how the entire socio-politics of a country is controlled by a handful of people. We took a lot of the case studies from the 1980s and 2000s to see how tax cuts didn't result in the expected output, mainly in terms of job creation.
What we need to do instead is to highlight the need for equitable, inclusive economic policies that directly address the needs of lower- and middle-income groups, so that they also receive a fair chance to climb up the ladder. It is time we reclaim the essence of pure and pragmatic capitalism with competition, and what exactly benefits the society, not what benefits only the people at the top.
The Great Gatsby
The novel published in 1925 later converted to a hit Hollywood movie shows the economic situation in the US in 1920s. It was called as the roaring 20s due to the economic boom, and lavish spending that happened. The story is of a rich man Gatsby who threw parties flaunting his wealth when common people suffered. We exactly know what happened 4 years later.
Sustainable growth requires prioritizing human capital, equity, and resilience over wealth concentration and hoarding of economic capital.
References
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Holland, R. (2018, July 2). Corporate tax cuts don’t increase middle-class incomes. Harvard Business School. https://www.library.hbs.edu/working-knowledge/corporate-tax-cuts-don-t-increase-middle- class-incomes
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Trickle-down theory | Economics | Research Starters | EBSCO Research. (n.d.). EBSCO. https://www.ebsco.com/research-starters/economics/trickle-down-theory
Steele, J. B. (2023, June 26). How four decades of tax cuts fueled inequality Center for Public Integrity https://publicintegrity.org/inequality-poverty-opportunity/taxes/unequal-burden/how-four-decades-of- tax-cuts-fueled-inequality/
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https://www.reaganfoundation.org/ronald-reagan/the-presidency/economic-policy
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