Trickle-Down Theory


DEFINITION of 'Trickle-Down Theory'

An economic idea which states that decreasing marginal and capital gains tax rates - especially for corporations, investors and entrepreneurs - can stimulate production in the overall economy. According to trickle-down theory proponents, this stimulus leads to economic growth and wealth creation that benefits everyone, not just those who pay the lower tax rates.

BREAKING DOWN 'Trickle-Down Theory'

President Reagan's economic policies, commonly referred to as "Reaganomics" or supply-side economics, were based on trickle-down theory. The idea is that with a lower tax burden and increased investment, business can produce (or supply) more, increasing employment and worker pay. Reagan initially slashed the top income-tax rate from 70% to 50%. Trickle-down policy’s detractors see the policy as tax cuts for the rich and don’t think the tax cuts benefit lower-income earners.

A contrasting theory, Keynesianism, is based on stimulating demand through government spending and other government interventions. An increase in government spending necessitates an increase in income-tax rates – the opposite of what trickle-down theory advocates. Trickle-down theory does not support government intervention in the economy.

According to the trickle-down theory, if tax rates are lower, people have an incentive to work more because they get to keep more of the income they earn. They then spend or invest that income, and either of these activities will improve everyone’s prosperity, not just the prosperity of those in the highest income brackets. What’s more, in the end, the government may actually collect more income tax despite the lower tax rates because of the additional work performed. The Laffer Curve shows how this relationship works. If the government taxes 0% of income or 100% of income, it takes in no money. In between these two extremes, tax revenues vary because different tax rates encourage people to work more or to take more leisure time.

  1. Keynesian Economics

    An economic theory of total spending in the economy and its effects ...
  2. Business Economics

    The study of the financial issues and challenges faced by corporations. ...
  3. Experimental Economics

    A branch of economics that focuses on individual behavior in ...
  4. Financial Economics

    A branch of economics that analyzes the use and distribution ...
  5. Oprah Effect

    The Oprah effect is an expression referring to the effect that ...
  6. Reaganomics

    A popular term used to refer to the economic policies of Ronald ...
Related Articles
  1. Economics

    Economics Basics

    Learn economics principles such as the relationship of supply and demand, elasticity, utility, and more!
  2. Economics

    The Economics Of Labor Mobility

    Loosening labor restrictions has both good and bad effects for a country and its workers.
  3. Economics

    Understanding Supply-Side Economics

    Does the amount of goods and services produced set the pace for economic growth? Here are the arguments.
  4. Economics

    Adam Smith: The Father Of Economics

    This free thinker promoted free trade at a time when governments controlled most commercial interests.
  5. Economics

    The Uncertainty Of Economics: Exploring The Dismal Science

    Learning about the study of economics can help you understand why you face contradictions in the market.
  6. Economics

    A Practical Look At Microeconomics

    Learn how individual decision-making turns the gears of our economy.
  7. Fundamental Analysis

    Hamburger Economics: The Big Mac Index

    In theory, PPP stands up much better than it does in reality. Find out how to evaluate currencies according to the price of a Big Mac.
  8. Fundamental Analysis

    The Difference Between Finance And Economics

    Learn the differences between these closely related disciplines and how they inform and influence each other.
  9. Taxes

    How Your Tax Rate Is Determined

    Feel like the government always has its hand in your pocket? Learn the theory behind how it decides how much to take.
  10. Bonds & Fixed Income

    Can Keynesian Economics Reduce Boom-Bust Cycles?

    Learn about a British economist's proposed solution to a common economic problem.
  1. Why is the Cayman Islands considered a tax haven?

    The Cayman Islands is one of the most well-known tax havens in the world. Unlike most countries, the Cayman Islands does ... Read Full Answer >>
  2. Why is Panama considered a tax haven?

    The Republic of Panama is considered one of the most well-established pure tax havens in the Caribbean due to extensive legislation ... Read Full Answer >>
  3. How do I get out of my annuity and transfer to a new one?

    If you decide your current annuity is not for you, there is nothing stopping you from transferring your investment to a new ... Read Full Answer >>
  4. Are Cafeteria plans exempt from Social Security?

    Typically, qualified benefits offered through cafeteria plans are exempt from Social Security taxes. However, certain types ... Read Full Answer >>
  5. Why is Andorra considered a tax haven?

    Andorra is one of many locations around the globe considered a tax haven because of its relatively lenient tax laws. However, ... Read Full Answer >>
  6. How are variable annuities taxed at death?

    If the owner of a variable annuity dies before receiving full payment, his beneficiary must pay taxes on any earnings received. ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  2. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  3. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  4. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  5. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds that they deploy in their business. The cost of funds is one ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!