“Trickle-down economics“, also referred to as “trickle-down theory“, is a term associated with laissez-faire capitalism in general and more specifically supply-side economics, used to characterize economic policies as favoring the wealthy or privileged.
In recent history, the phrase has been used by critics of supply-side economic policies, such as “Reaganomics“. David Stockman, who as Reagan’s budget director championed Reagan’s tax cuts at first, but then became critical of them, told journalist William Greider that the “supply-side economics” is the trickle-down idea: “It’s kind of hard to sell ‘trickle down,’ so the supply-side formula was the only way to get a tax policy that was really ‘trickle down.’ Supply-side is ‘trickle-down’ theory.” Political opponents of the Reagan administration soon seized on this language in an effort to brand the administration as caring only about the wealthy.
Trickle-Down Economic Theory
Trickle-down economic theory is like supply-side economics. That states that all tax cuts, whether for businesses or workers, spur economic growth. Trickle-down theory is more detailed than supply-side theory. It says targeted tax cuts work better than general ones. It advocates cuts to corporate, capital gains, and savings taxes.
Both trickle-down and supply-side economists use the Laffer Curve to prove their theories. Arthur Laffer showed how tax cuts provide a powerful multiplication effect. Over time, they create enough growth to replace any lost government revenue. That’s because the expanded, prosperous economy provides a larger tax base.
But Laffer warned that this effect works best when taxes are in the “Prohibitive Range.” Otherwise, tax cuts will only lower government revenue without stimulating economic growth.
Did It Work?
During the Reagan Administration, it seemed that trickle-down economics worked. Reagan cut taxes significantly. The top tax rate fell from 70 percent (for those earning $108,000+) to 28 percent (for anyone with an income of $18,500 or more). The corporate tax rate was also cut, from 46 percent to 40 percent.
Trickle-down economics was not the only reason for the prosperity. Reagan not only cut taxes, but he also increased government spending by 2.5 percent a year. He almost tripled the Federal debt. It grew from $997 billion in 1981 to $2.85 trillion in 1989. Most of the new spending went to defense. It supported Reagan’s successful efforts to end the Cold War and bring down the Soviet Union. Trickle-down economics, in its pure form, was never tested. It’s more likely that massive government spending ended the recession. (Source: William A. Niskanen, “Reaganomics,” Library of Economics and Liberty.)
To end the 2001 recession, President George W. Bush cut income taxes with JGTRRA. That ended the recession by November of that year. But unemployment rose to 6 percent, so Bush cut business taxes with EGTRRA in 2003.
It appeared that the tax cuts worked. At the same time, the Federal Reserve lowered the Fed funds rate from 6 percent to 1 percent during this same period. It’s unclear whether tax cuts or another stimulus were what worked.
Trickle-down economics says that Reagan’s lower tax rates should have helped all income levels.
In fact, the exact opposite occurred. Income inequality worsened. Between 1979 and 2005, after-tax household income rose 6 percent for the bottom fifth. That sounds great until you see what happened for the top fifth — an 80 percent increase in income. The top 1 percent saw their income triple. Instead of trickling down, it appears that prosperity trickled up. (Source: Steven Greenhouse, The Big Squeeze, pp.6-9.)