Loading the player...

What is the 'Trickle-Down Theory'

Trickle-down economics, or “trickle-down theory,” states that tax breaks and benefits for corporations and the wealthy will trickle down to everyone else. It argues for income and capital gains tax breaks or other financial benefits to large businesses, investors and entrepreneurs to stimulate economic growth. The argument hinges on two assumptions: All members of society benefit from growth, and growth is most likely to come from those with the resources and skills to increase productive output.

BREAKING DOWN 'Trickle-Down Theory'

Trickle-down economics is political, not scientific. Although it is commonly associated with supply-side economics, there is no single comprehensive economic policy identified as trickle-down economics. Any policy can be considered “trickle-down” if the following are true: Frst, a principal mechanism of the policy disproportionately benefits wealthy businesses and individuals in the short run. Second, the policy is designed to boost standards of living for all individuals in the long run.

Examples include the U.S. bank bailouts of 2008 and the Common Agricultural Policy (CAP) of the European Union.

Origins

The first reference to trickle-down economics came from American comedian and commentator Will Rogers, who used it to derisively describe President Herbert Hoover’s stimulus efforts during the Great Depression. More recently, opponents of President Ronald Reagan used the term to attack his income tax cuts.

Trickle-Down and the Laffer Curve

American economist Arthur Laffer, an advisor to the Reagan administration, developed a bell-curve style analysis that plotted the relationship between changes in the official government tax rate and actual tax receipts. This became known as the Laffer Curve.

The nonlinear shape of the Laffer Curve suggested taxes could be too light or too onerous to produce maximum revenue; in other words, a 0 percent income tax rate and a 100 percent income tax rate each produce $0 in receipts to the government. At 0 percent, no tax can be collected; at 100 percent, there is no incentive to generate income. This should mean that specific cuts in tax rates would boost total receipts by encouraging more taxable income.

Laffer’s idea that tax cuts could boost growth and tax revenue was quickly labeled “trickle-down.” Between 1980 and 1988, the top marginal tax rate in the United States fell from 70 to 28 percent. Between 1981 and 1989, total federal receipts increased from $599 to $991 billion. This empirically supported one of the assumptions of the Laffer Curve. However, it neither shows nor proves a correlation between a reduction in top tax rates and economic benefits to low- and medium-income earners.

Forms and Problems

Trickle-down economics comes in many forms. Supply-side arguments, generally associated with tax cuts for high earners, suggest the wealthy would be more incentivized to raise output and create better jobs. Demand-side arguments, associated with subsidies and tariffs, argue the wealthy need protections to keep paying their employees or to raise spending.

All trickle-down policies, however, transfer wealth and advantages from all taxpayers towards an already wealthy few. This interventionism necessarily distorts the economic structure. In typical free markets, those at the top can only increase their wealth by providing more valuable goods and services, not before.

Trickle-Down Economics Today

Many Republicans use the trickle-down theory to guide their policies. But it is still very heavily debated even today. President Donald Trump proposed cutting taxes for corporations and the wealthy in 2017. His tax plan would see the corporate tax rate reduced to 20 percent, cut income tax rates, double the standard deduction and cut personal exemptions. Critics of the plan said the top 1 percent of would larger tax cut than those in lower income brackets. Other critics said any economic growth from the proposal would not offset any loss of revenue from the cuts. 

RELATED TERMS
  1. Effective Tax Rate

    The effective tax rate is the average rate at which an individual ...
  2. Progressive Tax

    A progressive tax is a tax that puts a lower rate on low-income ...
  3. Federal Income Tax

    A federal income tax is levied by the United States Internal ...
  4. Tax Rate

    A tax rate is the percentage at which an individual or corporation ...
  5. Marginal Tax Rate

    A marginal tax rate is the amount of tax paid on an additional ...
  6. Income Tax

    A tax that governments impose on financial income generated by ...
Related Articles
  1. Taxes

    How Your Tax Rate Is Determined

    Feel like the government always has its hand in your pocket? Learn the theory behind its decision-making on taxing you.
  2. Taxes

    Parties For Taxes: Republicans Vs. Democrats

    Read about the political parties' differences in tax ideology, and how it can affect your paycheck.
  3. Taxes

    Why America's Taxes Are Too Low

    The solution to America's economic woes may not be in lowering taxes further, but may, in fact, lie in increasing them.
  4. Taxes

    Who Does The Current Tax Code Benefit?

    Are the non-workers benefiting from the current tax code in any way or is it the wealthy who are still getting the big breaks?
  5. Taxes

    What All the Candidates’ Tax Plans Are Missing

    The presidential candidates have starkly different tax-reform proposals – but none of them gets to the real problem of America's tax system.
  6. Taxes

    How The Wealthy Slash Their Income Tax Bills

    Many of these tax-minimization strategies can be used by anyone. Find out how you can pay taxes like a millionaire.
  7. Taxes

    Congress Tackles Massive Revision of the Tax Code

    Congress is about to overhaul the tax code. What does this mean for investors?
  8. Taxes

    Opinion: Trump-Branded Taxes - Another Luxury Product

    Trump's tax plan offers less and less to most taxpayers – and more and more to the top tier.
  9. Insights

    Opinion: Why Corporate Tax Cuts Won't Make America Grow

    The federal debt will go up and, surprisingly, a number of corporations will actually lose money if the Trump tax plan becomes law.
  10. Insights

    How Fortune 500 Companies Avoid Paying Income Tax

    President Donald Trump is not alone in not paying taxes.
RELATED FAQS
  1. What do economists believe causes economic growth?

    Learn the different theories for what economists believe causes economic growth, including the big differences between supply-side ... Read Answer >>
  2. How does the marginal tax rate system work?

    The marginal tax rate is the rate of tax that income earners incur on each additional dollar of income. Read Answer >>
  3. What is the difference between a state income tax and a federal income tax?

    Learn the difference between state income tax and federal income tax based on tax rates, deductions, tax credits and taxable ... Read Answer >>
Hot Definitions
  1. Futures Contract

    An agreement to buy or sell the underlying commodity or asset at a specific price at a future date.
  2. Yield Curve

    A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but ...
  3. Portfolio

    A portfolio is a grouping of financial assets such as stocks, bonds and cash equivalents, also their mutual, exchange-traded ...
  4. Gross Profit

    Gross profit is the profit a company makes after deducting the costs of making and selling its products, or the costs of ...
  5. Diversification

    Diversification is the strategy of investing in a variety of securities in order to lower the risk involved with putting ...
  6. Intrinsic Value

    Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, and may differ ...
Trading Center