Does Trickle-down Economics Add Up – or Is It a Drop in the Bucket?
An old term of questionable meaning is getting a new lease on
life: Trickle-down economics. And to many in media and liberal circles,
it has once again emerged as the great hobgoblin of our time.
“Trump and conservatives in Congress are planning a big tax cut for
millionaires and billionaires,” Robert Reich, who served as secretary of
labor during the Clinton administration, wrote in Newsweek recently.
“To justify it they’re using the oldest song in their playbook,
claiming tax cuts on the rich will trickle down to working families in
the form of stronger economic growth. Baloney. Trickle-down economics is
a cruel joke.”
But what is trickle-down economics? The answer depends on who is
saying it and what public opinion buttons they are trying to press. Kent Smetters,
Wharton professor of business economics and public policy, says that
trickle-down economics is a term created to disparage supply-side
economics.
“It is just a clever negative sound bite,” says Smetters, faculty director of the Penn Wharton Budget Model (PWBM).
“Detractors claim that supply-side economics is about giving tax breaks
to the rich. The rich then engage in more economic behavior, such as
buying more stuff or hiring more workers; that eventually ‘trickles
down’ to the non-rich who get the crumbs that fall from the table.”
Many others have pointed out the folly of using the term — that no
real economic model or serious school of thought stands behind what has
long been a term of art at the intersection of politics and media. “I
have a little bit of a hard time with the terminology and the idea of
trickle-down economics,” says Wharton professor of finance Joao F.
Gomes. “Although everyone in the popular press has a somewhat different
characterization of what this means, this is not something we have
tested or seriously theorized about as economists.”
But if there is no substance behind trickle-down — just pejorative
intent — the Trump administration itself has curiously invoked the term
in its zeal to sell its tax plan to the American public.
“I don’t believe that we’ve set out to create a tax cut for the
wealthy. If someone’s getting a tax cut, I’m not upset that they’re
getting a tax cut. I’m really not upset,” Gary Cohn, President Trump’s
chief economic adviser, told CNBC recently.
“We create wage inflation, which means the workers get paid more; the
workers have more disposable income, the workers spend more. And we see
the whole trickle-down through the economy, and that’s good for the
economy.”
“Describing this view as ‘trickle-down economics’ would
be akin to supply-siders describing their detractors as communists, a
label that would certainly be rejected as well.”–Kent Smetters
It’s not clear that most Americans believe that anything good will
eventually trickle down to them from the still-unfinished overhaul. When
asked who the Republican tax plan would help most, 76% of respondents
to a December 2-5 CBS poll
of 1,120 adults nationwide said it would be large corporations, with
69% saying wealthy Americans would benefit most. Just 31% named the
middle class as winners, with “you and your family” trailing at 24%.
A Politically Infused Etymology
The Oxford English Dictionary defines the particularly colorful
phrase trickle down as the notion that wealth will “gradually benefit
the poorest as a result of the increasing wealth of the richest.” The
term’s popularization is often traced to a 1932 syndicated column
by Will Rogers in which the humorist referred to money “appropriated
for the top in the hopes that it would trickle down to the needy. Mr.
Hoover was an engineer. He knew that water trickles down. Put it uphill
and let it go and it will reach the driest little spot. But he didn’t
know that money trickled up. Give it to the people at the bottom and the
people at the top will have it before night, anyhow.”
“Favors for the few and prayers for the many” is what Adlai Stevenson
II called it in an address to a 1954 Democratic Party rally in Detroit
while stumping nationally for candidates.
A 1971 New York Times editorial referred to organized
labor’s view that President Nixon was embracing “old-line ‘trickle down’
economics in the conventional Republican mold” by suggesting that
“workers will benefit most by large-scale tax concessions to industry
designed to spur investment in modernized plants and thus strengthen the
competitive position of American business.”
And when President Ford proposed a tax overhaul in 1974, Sen. Edward
M. Kennedy dismissed it as “a throwback to the trickle-down economics
the nation has traditionally had to suffer under Republican Presidents.”
The phrase’s resonance today, of course, emanates from the Reagan
era, and while it may have stood the test of time, longevity has not
conferred clarity. Part of the problem is that “trickle down” lacks a
universally understood meaning. Smetters says the idea of tax breaks for
the rich eventually producing benefits to the poor has never been part
of supply-side economics.
“Supply-siders believe — correctly or not — that lower taxes lifts
all boats together,” he says. “Growth is not a flow of resources that
cascade from rich to non-rich. In fact, many supply-siders argue that
lower taxes benefit workers more than capital owners through
international capital flows. Whether this argument is right or wrong is a
legitimate issue. But describing this view as ‘trickle-down economics’
would be akin to supply-siders describing their detractors as
communists, a label that would certainly be rejected as well.”
Semantics aside, most agree that the right kind of stimulus can be
efficacious to growth. “The term ‘trickle-down economics’ doesn’t really
represent a cohesive economic theory,” says Wharton professor of
business economics and public policy Benjamin Lockwood. “It’s a term used, often negatively, to characterize the view that reducing taxes on the rich will benefit the non-rich.”
There are a number of reasons why tax cuts for high earners could
theoretically make others better off, he says. “Economists have long
emphasized that taxes don’t necessarily ‘stick’ where you levy them —
for example, a tax cut on corporate profits could raise workers’ wages.
And if taxes are very high, reducing them can theoretically spur
economic activity enough that tax revenues actually increase, which may
have been the case in the 1950s, when top income tax rates exceeded
90%.”
However, he says, there’s little evidence to suggest that this would
be the case for the current GOP proposal. “Most recent estimates suggest
that the majority of corporate income taxes fall on business owners and
shareholders, with only a minority falling on wages. And the fiscal
crisis generated by Kansas’s recent tax cuts suggests today’s tax rates
aren’t high enough for such cuts to be revenue-generating.”
“How much growth will we get from this plan? It depends on final details and things we truly don’t know much about.”–Joao Gomes
The current tax bill is still a moving target, but the Penn Wharton
Budget Model finds that the boost to GDP produced by the tax cuts would
not be enough to pay for the tax cuts.
Lower taxes will probably add to growth. “Almost all economists
accept that,” says Gomes. “How much and for how long is another
question, and that’s where we disagree. There are several reasons for
that. Some of us will say it is because lower taxes encourage people to
work more and maybe corporations to invest more. If the tax cuts are
long lived, this will raise national income for a long time. Republicans
tend to start from this point.” Others will say it is because lower
taxes will put money in people’s pockets and encourage spending which in
turn creates jobs for a short time, even when the tax cuts are also
temporary, Gomes adds. “Democrats tend to start from here. Indeed, this
was the rationale for temporary cuts under President Obama. As I said,
most economists agree that each of these arguments has merit. However,
long-term cuts that stimulate work and investment cost more money and
tend to benefit people who pay higher rates and/or capital gains taxes.
These tend to be higher-income individuals.”
Do tax cuts pay for themselves, as some like to suggest?
“Almost surely not,” says Gomes. “But it is also important to say, to
be absolutely fair, neither does spending on infrastructure, and that
has not stopped left-wing economists from proposing it with the same
fuzzy math that right-wingers support with these cuts. For an unbiased
observer, there really is very little to choose between the fiscal
probity of Democrats and Republicans.
“How much growth will we get from this plan? It depends on final
details and things we truly don’t know much about,” Gomes continues.
“Will it encourage people to work more? I would estimate yes, maybe a
little but not very much. Will it encourage investment? Absolutely. Will
it encourage corporations to relocate operations to the U.S.? Maybe,
but the details are going to matter a lot.”
Looking for Growth in All the Right Places
The details of the tax plan are still opaque. One key unknown is the
extent to which tax savings might be applied in ways that produce
growth.
“Under the current tax proposal, the trickle-down economics becomes:
‘we’ll give a big cut in the corporate tax rate with the hope that those
workers will benefit from the resulting new investment.’ It’s not
surprising that if you tax returns on investments less there will be
more investments,” says Robert P. Inman, Wharton professor of finance.
“The real question becomes: How big of an effect on investment will
there be, and if there is new investment in capital, will it benefit
workers?
“The term ‘trickle-down economics’ doesn’t really represent a cohesive economic theory.”–Benjamin Lockwood
“For example, if businesses invest that in existing real estate or
share buy-backs,” Inman continues, “there is probably not going to be
much of an impact on employment or worker wages. However, investing in a
new building or in new capital equipment will employ people and
potentially increase worker productivity. In that case there will be a
positive effect on employment and on worker wages.”
But how many jobs? And wages of what kind?
“I suspect most of the new machinery will be very sophisticated,
high-tech, investment. If so, the trickle down, the wage premium for
those at the lower ends of the income distribution, will be rather
modest. The trickle-down will probably stop at [jobs paying] about
$50,000.”
Inman recalls the effects of President George W. Bush’s 2004-2005
overseas corporate profits repatriation program. “The idea was that it
would lead to a big influx of cash on the investment side, but what
corporations ended up doing was buying back shares. That was an
investment, but an investment that didn’t create any jobs.”
Of the new tax plan’s repatriation of earnings — about $2.5 trillion
sitting offshore — that would be automatically brought home and taxed at
a special rate, Smetters says it’s likely that some of it will
translate into higher dividends, some into stock repurchases and some of
it will be invested. “We don’t think the investment channel is going to
be nearly as big as some people will say, and the reason why is that
there are already some ways of clever financing,” he recently said in a separate Knowledge@Wharton interview.
Inman does believe that lowering the corporate tax rate makes sense,
but that it needs to happen along with closing loopholes. “Close the
loopholes, then see how much money you have and lower the tax rate
accordingly,” he suggests.
On the question of whether the GOP’s plan will increase income and
wealth inequality, a lot depends on what the exact changes to the estate
tax end up being, says Gomes. “Still, from an inequality standpoint it
would be great to see the elimination of the state and local tax and
home mortgage deductions, which are mostly gifts to the top 20% of the
income distribution. Eliminating these deductions while cutting tax
rates is also the sort of ‘revenue neutral’ change that most economists
would applaud.”
One aspect of this debate that is under-emphasized, says Lockwood, is
the potential for other types of targeted tax cuts to generate
beneficial spillovers. These are benefits that could bubble up from low
earners, or flow sideways from middle earners, rather than trickling
down from the top.
“There is evidence that cutting taxes, or targeting
spending, on specific middle-class professions, including teaching and
basic research, would have quite large beneficial spillovers.”–Benjamin Lockwood
“In fact, there is evidence that cutting taxes, or targeting
spending, on specific middle-class professions, including teaching and
basic research, would have quite large beneficial spillovers,” he says.
In a recent paper co-authored with Charles G. Nathanson of Northwestern
University and E. Glen Weyl of Microsoft Research and Yale University,
Lockwood writes that some professions have “spillovers” — that the
social value of an individual’s work can be much higher, or much lower,
than that individual’s compensation.
“Some spillovers are quite large,” they write in a Harvard Business Review piece about the paper “Taxation and the Allocation of Talent,” published in the Journal of Political Economy. “Given how much good
teachers raise the eventual incomes of their students, we calculate
that spillovers from teachers are twice as large as the salaries
teachers are paid. The benefits from medical research are even
larger, amounting to over one-fifth of total income in the U.S. “On the
other hand, some sectors involve ‘zero sum’ endeavors, in which profits
come at the expense of other market participants. Examples include
excessive litigation or financial traders trying to beat the market.”
They examine two potential types of tax policies. In one, raising top
tax rates would, in theory, encourage workers to choose lower-paying
jobs, compelling some to gravitate toward more socially valuable
professions. In the other, the government would tax or subsidize some
professions more than others.
The first approach would do little to spur economic growth, they
conclude. The second could boost growth dramatically. Rather than
advocating a rewrite of tax code with different rates for different
jobs, the authors recommend a rewards system that would raise salaries
and award merit pay.
“There is no economist who doesn’t agree that if you give
somebody money, it’s going to have effects elsewhere in the economy.
The only issue is how do those effects play out….”–Robert Inman
Of growth stimulators in the current GOP tax proposal, Gomes says one
aspect that is appealing is the expensing of investment. Firms will be
allowed to deduct all investment expenses from their corporate taxes
immediately, instead of slowly over time. “This change more than any
others should encourage them to invest and boost our economy in the
short and long runs. It’s a clever idea that economists have been
advocating for years on the left and the right,” he says.
What he likes least: The fact that the plan is unlikely to pay for
itself. “We should be raising revenues elsewhere to offset the cost of
[many] good ideas. We are adding to the burden of the federal debt when
we should be reducing it. Admittedly it’s not a lot relative to GDP, and
the bond market is not concerned about the government’s ability to
repay higher debt. But it goes in the wrong direction.”
Gomes says “there are several good ideas in the plan. The main
problems might be the overall cost and the lack of phase-in for some of
the changes that are likely to be very disruptive.”
It is, however, a complex plan, he says, and “obviously Republicans
exaggerate its virtues and Democrats the defects. The truth is in the
middle.”
Fluidic imagery aside, change is coming. Says Inman: “There is no
economist who doesn’t agree that if you give somebody money, it’s going
to have effects elsewhere in the economy. The only issue is how do those
effects play out, and who are the beneficiaries?
For conservatives, he notes, “trickle-down is a flood, and for liberals it’s a drip.”
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Wildberries
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Seraphim Hanisch
