A lot of controversy in economics on the political stage comes from trickle down economics and whether it even works or not. The idea is that if we give sufficient tax cuts to corporations, they'll use that money to expand and create more jobs and just overall bettering the economy for everyone. My question is, why can't that work the other way around? If you give the working class just as much in tax cuts, they'll eventually spend that money to where it does end up at an American corporation. And in my opinion, this way is more capitalist, because the consumers decide what businesses get what percentage of their tax cut, instead of just multiplying the corporation's wealth.
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2$\begingroup$ I suggest that you define what you mean by "Trickle Down" and "Trickle Up" economics. In my mind, "tax cuts to corporations" and tax cuts for the "working class" are both "Trickle Up" economics. $\endgroup$– MathematicianCommented Dec 20, 2017 at 12:56
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$\begingroup$ Generally, whenever there's a trickle, it runs toward the fat cats. If you look at some references, "trickle down" has never been convincingly shown to work (though it has bee shown to NOT work several times). $\endgroup$– Hot LicksCommented Dec 20, 2017 at 14:16
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$\begingroup$ It should be noted that a cut in corporate income tax rates does NOT encourage investment (in either employees or capital equipment) in the taxed corporation, for the simple reason that income that's invested back in the company is already excluded from taxation in most cases. Cutting corporate taxes DOES encourage "rewarding" corporate bitwigs, however. $\endgroup$– Hot LicksCommented Dec 21, 2017 at 0:42
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1$\begingroup$ As long as people are fooled into continually focusing on tax rates instead of focusing on the regulations that allow for the wealthy to become even more wealthy then the trend of disparity will continue even as tax rates go up and down. The problem is not tax rates, it is the protectionist rules, the ability of corporations (particularly the finance sector) to pass risk to the tax payer instead of their personal wealth, the ability to "write-off" expenses that provide no societal or business value but instead are just corporate welfare mechanisms... $\endgroup$– DunkCommented Dec 21, 2017 at 21:09
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1$\begingroup$ ... These are just a few issues that if tackled would actually be solutions instead of feel-good memes intended to get people out to vote but don't really intend to solve anything. Both parties are in it to benefit their wealthy donors above everything else. After all, those wealthy donors provide the insider trading information that congress exempted themselves from being prosecuted for and also the lucrative job/bribe opportunities once their political career ends. $\endgroup$– DunkCommented Dec 21, 2017 at 21:10
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5 Answers
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In Keynesian economics, yes, it can work the other way around - in fact, it may even be more effective. I don't have any textbooks or sources handy, but in general, people with lower incomes have a higher marginal propensity to consume. That is, if you give a poor person an extra dollar, they will spend more of that dollar, and save less of it, than someone who is wealthier. Since more of the additional money is spent, the tax cut will have more of a stimulative effect on the economy. In Keynesian terms, the fiscal multiplier will be larger.
Here are some links that go over this in more detail. And if you really want to understand it, any decent macroeconomics textbook should cover this pretty thoroughly.
https://www.investopedia.com/exam-guide/cfa-level-1/macroeconomics/multiplier-effect.asp https://en.wikipedia.org/wiki/Marginal_propensity_to_consume#MPC_and_the_multiplier https://en.wikipedia.org/wiki/Fiscal_multiplier#Marginal_Propensity_to_Consume https://scandalum.wordpress.com/2007/10/17/10-the-marginal-propensity-to-consume-and-the-multiplier/
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$\begingroup$ Thank you for the great explanation and the extra sources! Now the question is, why isn't this principle the core of our tax plans, and not the "trickle down" theory? $\endgroup$– Badr BCommented Dec 20, 2017 at 21:06
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$\begingroup$ @BadrB - Follow the money. Who makes the biggest political donations? $\endgroup$ Commented Dec 20, 2017 at 21:38
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1$\begingroup$ well now we're getting into politics, by in my fairly left-wing opinion: "economic elites and organized groups representing business interests have substantial independent impacts on U.S. government policy, while average citizens and mass-based interest groups have little or no independent influence." demos.org/blog/2/18/15/… $\endgroup$– krockCommented Dec 20, 2017 at 21:44
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As you learn more about economics you should gradually come to distinguish the vocabulary of economics from that of politics (which is also not the same as political science). When politicians or political activists speak, they use a variety of terms that are very vaguely defined, and sometimes outright derogatory. They are not actually meant to convey exact economic concepts or ideas, but more like feelings. "Trickle down economics" is an example. "Neo-liberism" is another example. You won't find any formally trained economists discussing "trickle down economics" or "neo-liberist" policies simply because these are not properly defined concepts, i.e. they don't really mean anything specific. In order to discuss productively with economists and generally any scholar from a discipline that is based on the scientific method (biology, physics, statistics, etc.), it is important to acquire the right vocabulary. The dictionary or an encyclopedia is usually a good place to start.
P.S. it is not a coincidence that controversy tends to stir around topics that are not discussed in scientific terms - it is difficult for people to agree on ideas if they can't articulate them :)
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$\begingroup$ Very good point. I've heard somewhere once that it was coined trickle down economics by its skeptics to make it sound ridiculous. But I admit I'm guilty as well, because after looking into what it's actually called and what it is, it still seemed to fit the term "trickle down" in my mind. $\endgroup$– Badr BCommented Dec 20, 2017 at 21:02
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$\begingroup$ If you look at the history of the term "trickle down", it goes back a long way and has had several different connotations. $\endgroup$ Commented Dec 20, 2017 at 21:40
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The overall effect of reducing tax on a factor of production (or its owner) will depend on at least two things:
- The change in the quantity of the factor used in production in response to the increase in the post-tax factor return.
- The use of the extra disposable income resulting from the tax cut.
The answer by @krock addresses 2. I would just add that whether a tax cut (for corporations or labour) will have a Keynesian type stimulative effect on an economy depends on conditions. It will not have such an effect if the economy is already at full capacity, or if a restrictive monetary policy offsets the effect of the fiscal stimulus.
Focusing now on 1, an increase in the post-tax return to capital is likely, ceteris paribus, to result over time in an increase in the quantity of capital. This is partly because it will encourage savers, seeking the best return subject to prudent diversification, to invest more in productive capital rather than other assets such as housing or government securities. To the extent that financial capital is internationally mobile, it will also encourage more of the investment in productive capital to be in domestic rather than foreign capital. The effect of increasing the quantity of productive capital in the economy, assuming a constant labour supply and assuming a Cobb-Douglas or similar production function, will be to raise the marginal product of labour and therefore (to the extent that the marginal productivity theory of distribution is valid) to raise wages (which could loosely be described as “trickle down”). A mathematical treatment of this process is in Greg Mankiw’s blog (October 18th 2017).
The effect of an increase in the post-tax return to labour, on the other hand, is hard to predict. It raises the opportunity cost of leisure time, which could lead some (if they have a choice) to work more hours (a substitution effect). If, in aggregate, hours worked were to increase, then (adapting the above reasoning) the marginal product of capital and therefore the return on capital would increase (which could loosely be described as “trickle up”). However, an increase in the post-tax return to labour would also mean that a desired level of income can be achieved from fewer working hours, which could lead some to reduce their hours (an income effect). There is evidence that the income and substitution effects often approximately offset each other, so that changes in returns to labour have little effect on hours worked (see for example Kimball & Shapiro 2008, especially pp 3-4)
Thus there is a key difference between the responses of capital and labour to an increase in post-tax return. There is no equivalent, for capital, of the fact that a worker only has 24 hours in a day and derives utility from the non-working part of the day. Because of this, the response of capital to a tax cut is more predictable than that of labour and (loosely again) “trickle down” may be less dependent on circumstances than “trickle up”.
answered Dec 20, 2017 at 22:16
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‘Trickle up’ as you call it or ‘trickle down’ shouldn’t be the focus of inequality research done by economists (as this is ideologically driven rather than evidence based). The evidence does point towards excessive inequality causing worsening social outcomes. This is recognised by institutions such as the IMF and WB. Inequality research is also conducted by economists who examine structural economic inequalities. Development economists also research this question.
Quality of life measures are much more important to look at when considering how an economy is progressing. Quality of life measures should be viewed side-by-side with inequality metrics. Economic growth is only one component. It’s not the most important component. Economies that grow rapidly but only benefit a small subset of the population aren’t very effective tools for raising living standards for the most amount of people. This is a fairly utilitarian standpoint. There are some good studies about inequality that use economic measures such as the HDI versus economic inequality to determine how we should redistribute wealth and income. One of the most well-known study is titled The Spirit Level. Stiglitz and Krugman also have written extensively on these topics.
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In either case it could work or not work depending on where the money actually ends up. For instance, a lower income individual will have a higher MPC, but they also have incentive to spend their money on the most inexpensive item, which oftentimes is an import - thereby not trickling any money up to American corporations. On the other hand, the main motive for corporations is to make profit for its stockholders - not all of whom will spend their money in America. So either way, it depends. Which just proves that economic theory is much easier to quantify than economics in practice.
