Three things people get wrong about trickle-down economics

Economic theory and economic reality don’t always match up perfectly.

While theories like trickle-down economics suggest corporate tax cuts will eventually benefit the rest of society, it’s hard to predict what other factors may help – or hinder – the flow of money from the highest earners to the lowest ones.

“It’s a very complex system and people need to think more about how the system works,” said David Chan Smith an associate professor of history at Wilfred Laurier University who focuses on business history. “(There) are variables.”

Trickle-down economics, also known as supply-side economics, states that if you stimulate the productive side of the economy by cutting taxes on corporations, you will create supply. Those companies should use the money they saved on taxes to invest in factories, produce more goods and services and create more jobs – which means the benefits given to the corporations will, over time, trickle down to the rest of society.

But that’s not always the case.

Here are three of the top misconceptions about trickle-down economics:

• If you invest in companies, they will invest in you. While the theory suggests that tax cuts increase economic growth, there is no guarantee that a corporation will take the money it saves on taxes and use it to create jobs. That company can just as easily choose to use the extra cash to pay dividends to its shareholders, or to increase its CEO’s salary. When the Trump administration brought in tax cuts in the U.S. at the end of 2017, for instance, several companies were open about the fact that they didn’t plan to use the money they saved on taxes to create jobs. How big an impact the possible stimulus has will also depend on whether a reduced corporate tax rate drives more outside investment into the country.

• What’s good for the wealthy is good for everyone. There’s also no way to know how any economic stimulus created by supply-side economics will be distributed. And while tax cuts may boost the economy, they can also increase deficits – which can sometimes be offset by cuts to social services predominately used by middle-class or lower-income earners. There’s also an argument that high-income earners spend less than lower-income individuals, opting instead to invest or save their money, so any plan that benefits the wealthy will actually be less stimulating to the economy.

• It worked for Reagan, so it can work again. Back in 1981, then-U.S. President Ronald Reagan made use of supply-side economics to tackle tax rates as high as 70 per cent, with policies that were widely considered to end the recession. He also increased government spending, however, while the U.S. Federal Reserve moved to slash interest rates – two factors that could also be credited for the recovery. Another former U.S. President, George W. Bush, toyed with trickle-down theory in an attempt to deal with the downturn that followed 9/11, but his 2001 and 2003 tax cuts didn’t produce a major economic expansion or prevent the 2008 financial crisis. More recently, the state of Kansas tried to implement massive tax cuts, which failed to spur economic growth because taxes weren’t as high in 2017 as they had been in the late 1970s.

Even in cases where there’s been clear empirical evidence of major growth in the U.S. economy as a result of tax cuts, such as during Reagan’s tenure, there have always been different possible explanations for it, noted Smith.

“Can you conclusively attribute it to trickle down/supply-side economics?”, he said. “People debate that.”

3 years ago