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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. 

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