Breaking down trickle down economics

Analysis    | 3 Aug 2018 | Read 308 times
Breaking down trickle down economics

Much has been said about trickle down economics but not much has been studied about it. Politicians and even intellectuals have used the term plenty of times, although ironically, almost never by economists. Yet it is a political expression that still prevails around the world. The stubborn rhetoric was shown recently in Indonesia through two leading public figures. Despite opposing each other in current economic issues, both actually used and agreed on the theory of trickle down economics. It says much about the rigor of the expression if public figures on opposite sides would use the same term to make a point, albeit with different agendas. Unfortunately, trickle down economics actually has no degree of common and theoretical sense, and even evidence.

The general idea of trickle down economics is that the rich get richer by being given most of the wealth, and that their wealth will only eventually "trickle down" to the poor. Thus, supposedly making the poor more disadvantaged and ending up with mere scraps. A more vivid definition would be what a Labor Party MP from New Zealand described as "the rich pissing on the poor." The usual method of choice in trickle down economics, public figures would espouse, is the reduction of taxes on businesses and the rich. This would in turn, although the rich would end up with more wealth due to low tax rates, lead to more benefits and wealth to the poor because it would eventually “trickle down” to them.

This is nonsensical. Although it sounds right and appeals to our sense of justice, it is void of any common and theoretical sense, much less any economic theory. Perhaps that’s the reason why mostly politicians, instead of economists, use the term. Granted, it works great to build up emotional fervor among a voter base, but again, no economist has ever had such a theory or endorsed policies based on it.

“Giving more and more to those with the most”

Yet, politicians and public figures everywhere continue to use the political phrase. During his presidential campaign, President Obama helped explain trickle down economics by stating that it “says we should give more and more to those with the most, and hope that prosperity trickles down to everyone else.” What President Obama and many others are saying, is that we simply have been giving more to the rich by advocating policies that help them. Whether that’s a cut in taxes or capital gains, the idea is that the government is in fact, giving to the rich.

But economist Thomas Sowell asks us to consider something: to stop and think. He asks what is the point we give to person A in the hope that it trickles down to person B? Why not instead just cut the “middle-man” and give directly to person B? If you are worried that the wealth would only trickle down, then stop giving the wealth to the rich and give to the poor directly instead. Those who use the term trickle down economics should consider why parties who are responsible for letting the majority of wealth reach the rich, not allow far direct transfers to the poor instead.

Thus, in the case where governments are involved, instead of cutting tax rates in the expectations of the profits or wealth reaching to the poor, why not just take the wealth and give to the poor directly? Why have a “middle-man”, in this case the government, and let the wealth go directly to the poor instead of filtering through the rich? Why not enact a law that requires businesses and the rich to give directly to the poor and needy? In fact, it would probably be more cost-effective since no “brokerage” fees would be incurred. This so called zero-sum game spewed by many simply requires a reflection in logic.

Furthermore, consider how economic processes work. Anyone with a basic understanding of financial accounts know that profits benefit the owner after all sorts of expenses including salaries, initial and recurring investments, rental etc. have been paid. Moreover, profits do not come right away especially for people who start businesses. It takes a significant amount of time and risks for profits to eventually come in to businesses, if they are indeed successful.

Between the time of any initial investments and profits, which depending on industries could take years, many employees, services and costs have also been paid, giving many people including the poor more wealth and opportunities. Politicians that use the term trickle down hardly raise the issue because they know it is easier to talk about it then actually see the economic reality.

The expression and evidence of trickle down

The expression trickle down itself implies that the wealth is not transferred sufficiently and quickly enough from the rich to the poor. Instead of trickling down like a near empty water bottle, the wealth should pour like a waterfall. If it simply trickled down, the wealth would go overseas, or more to the rich creating more inequality, as the mentioned public figures would claim.

Thus, often without any discussion on what amount and/or how quickly the wealth should be transferred, public figures still state that the wealth must at least be transferred. But this is usually at a level that is deemed acceptable only by the politicians who use the term. Obviously, this raises numerous legitimate questions. But we can simply look to evidence of what happens when tax rates are increased or decreased, and how it can actually contradict the goals of those who exploit the political expression.

If the goal were to increase more wealth to be given to the poor, higher tax rates would be enacted to generate more tax revenue for the poor. But that isn’t entirely true. In the US, between 1980 and 1988, the top marginal tax rate decreased from 70% to 28%. Instead of less tax revenue or more wealth kept by the rich, total federal receipts increased from USD 599 to 991 billion between 1981 and 1989. In Indonesia, the total tax rate (% of commercial profits) decreased from 32.2% to 29.7% between 2013 and 2015, a time even when Indonesia was facing an economic downfall. Yet Indonesia recorded a growth in tax revenue (current LCU) of IDR 1.077 Quadrillion in 2013 to IDR 1.239 Quadrillion in 2015.

Whether that is acceptable or not, there is at least more wealth for the poor. And whether that is the general reality or not, there is hardly any mention of the aforementioned facts but rather more use of the political expression. Worries that if tax rates are not increased, the poor would not benefit and the rich would keep more of their wealth, could be misguided, as it shows tax revenue (or wealth to the government and then supposedly disbursed to the poor) still increases.

At the end, we should be careful whenever public figures, politicians and intellectuals use the term. When trying to understand economics and its effects on people’s incomes and livelihood, it would be wise to not resort to rhetoric and expressions. Too much is at stake to leave economics subject to “just a clever negative sound bite” (Penn Wharton Budget Model). It is worth noting too that the expression itself did not originate from an economist. It came from a comedian.

Daniel Kasenda

Aspiring Political Economy Observer and Thomas Sowell fan