What is the Trickle-Down Theory?

The trickle-down theory (otherwise known as trickle-down economics) postulates that applying special tax cuts to the rich and wealthy as well as bigger corporations with benefit the society, by later affecting everyone else. This model states that the application of income and capital tax cuts or the addition of other financial benefits to big corporations and large investors will alter the economic growth of a nation positively. It focuses on the belief that economic growth is most likely propelled by entities with the biggest resources and skills, and in a case where this growth this achieved, the community benefits at large.

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How does the Trickle-Down Theory Work? 

The trickle-down theory is not really an economic assumption but a political concept. While most persons will confuse it with supply-side economics, there is really no concept there that fits economic values. An example of the trickle-down theory is the US bank bailouts in 2008, as well as the European Unions Common Agricultural Policy (CAP). For a policy to be termed trickle-down, it must satisfy the following:

• It benefits only wealthy individuals and corporations in the short-run
• It is deemed to benefit the general public in the long run

During the Great Depression, American Comedian and Commentator made reference to the trickle-down economic when he used it to describe the then-President Herbert Hoovers stimulus efforts. In modern days, this term is used to attack President Ronald Reagans income tax cut.

Relationship between the Laffer Curve and Trickle-Down

During the Ronald Reagan administration, advisor Arthur Laffer proposed a bell-curve style pattern analysis for drafting the relationship between the alterations in the government tax rate and the nominal tax receipts. This analysis was rather termed the Laffer Curve. The shape of the curve proposes that there is a chance that taxes might not produce maximum revenue or receipts to the government. An example would be a light tax of 0% and a heavy tax of 100%. Both of them wont benefit the economy, because at 0%, taxes will not be incurred in the nation, and at 100% businesses wont operate because there is no chance of making a profit (which is the sole aim of business establishments). Thus, this model suggests that tax cuts would help increase receipts since it encourages more taxable income. This idea from Arthur Laffer was termed trickle-down as it suggested that tax cuts will boost economic growth and returns from tax. The US marginal tax rate fell from 70 to 20 between 1980 to 1988, and total receipts moved up to $991 billion from $599 billion between 1981 to 1989 when this theory was applied. This strengthened the Laffer Curve as expected, although the theory doesnt prove any relationship between tax cuts and its benefit to average and low-income employees.

Types of Trickle-Down and their Shortcomings

Trickle-down economics is displayed in two forms: supply-side and demand-side. In the former, the theory states that tax cuts for wealthy individuals and corporations would lead to more jobs and a better standard of living as these entities hold the resources required for an increase in economic growth. The demand-side, on the other hand, propose that these wealth entities need protection to continue paying employees and to increase spending. The supply side is mainly associated with tax cuts, while the demand-side is mostly associated with tariffs and subsidies. Both sides are keen on transferring wealth to those who are already wealthy, and this alters the normal economic structure of wealth acquisition and free-market which suggests that wealth is gained after providing services and not before providing services.

Modern Day Trickle-Down Theory

The trickle-down theory has become a ground for many Republican policies. In 2017, President Donald Trump suggested cutting down corporate taxes to 20%, in order to benefit wealthy entities. His plan was to reduce both corporate and income tax rates, double deduction standards and reduce personal exemption, which refers to a sum which can be deducted for an individual and their beneficiaries before a tax is filed. Criticisms occurred on both sides of the intended policies. Some of them claimed that the top 1% would benefit much more than those in the low-income earners circle. Others, however, claimed that the economic growth from the intended policy would not alter loss of revenue from tax cuts.

Related Topics

• Fiscal Policy
• Expansionary vs Contractionary Fiscal Policy
• Stabilization Policy
• Robin Hood Effect
• Ricardo Barro Effect
• Trickle Down Theory
• Discretionary Fiscal Policy 
•  Automatic Stabilizers
• Crowding Out Effect 
• Autonomous Spending
• Autonomous Consumption
• Golden Rule
• Ricardian Equivalence
• Balanced Budget - Deficit and Surplus
• National Debt
• Standardized Employment Budget
• Deficit Hawk
• Austerity
• Twin Deficits