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Stop Trying To Make “Trickle-Down Economics” An Economic Thing…Please…

July 30th, 2010 · 18 Comments
Macroeconomics · Policy

Whenever I think about this topic, I am reminded of a line from Mean Girls:

Gretchen: That is so fetch!
Regina: Gretchen, stop trying to make fetch happen! It’s not going to happen!

Here’s my version:

Policitians, pundits, etc.: Blah, blah, blah, trickle-down economics, blah, blah…
Economists: Stop trying to make trickle-down economics happen! It’s not going to happen!

It vexes me more than a small degree that I read and hear enough about this notion of trickle-down economics that I start thinking “clearly people wouldn’t still be attributing this to economists if there weren’t a bunch of economists out there still advocating the validity of this theory.” Then I start entertaining the possibility that my education has failed me, since I did in face pass my general exam in macroeconomics with flying colors (admittedly, the colors being those of mediocrity and red ink) but can’t seem to remember having covered this concept. (I suppose I could say the same about the Austrian School, and that certainly exists, so I am hesitant to automatically dismiss everything that hasn’t specifically been covered in class.) So what gives? Even Stephen Colbert thinks that trickle-down theories are a thing among economists:


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www.colbertnation.com
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Hehe – “A tax bomb! Quick, rich people, to your tax shelters!” I suppose that statement isn’t altogether absurd, since higher taxes increase the incentive to, well, avoid taxes. Also, Stephen Colbert seems to be on Krugman’s side of the octagon. But I digress…

So is Colbert saying that the wealthy use tax cuts to piss on the rest of society? Now that I think about it, that’s at least as reasonable a theory as this original trickle-down economics thing. To quote Mr. Colbert: “Economists know tax cuts for wealthy Americans benefit everyone…it’s even got a name, it’s called the trickle-down theory.” Allow me to respond: *clears throat* NO, NO WE DON’T KNOW THAT, THANK YOU VERY MUCH. But, like I said above, I get paranoid when what the world thinks and what I think are very different, so I decided to do some research:

Step 1: Wikipedia, obviously. It’s article on trickle-down economics seems to be reasonably informative, and I direct you to the line “Thomas Sowell claimed that, despite its political prominence, no trickle-down theory has ever existed among economists.” So there.

Step 2: There really shouldn’t be a need for a step 2, since if Wikipedia says it then it must be right. But I had some time on my hands, so I decided to look further into the matter. I present as Exhibit B a quote from Robert Frank in the New York Times:

Trickle-down theorists are quick to object that higher taxes would cause top earners to work less and take fewer risks, thereby stifling economic growth. In their familiar rhetorical flourish, they insist that a more progressive tax system would kill the geese that lay the golden eggs. On close examination, however, this claim is supported neither by economic theory nor by empirical evidence.

Now, Frank is a professor at Cornell, which ain’t too shabby, so I’m willing to bet that he knows his stuff. However, it *is* the New York Times, so I can’t entirely eschew the possibility that Frank is putting a liberal-yuppie spin on the matter. So the research continues…

Step 3: Get information straight from the research horse’s mouth. There is an academic research database called EconLit that provides search functionality over nearly all journals that are even remotely relevant to economics. So I put in a text search for “trickle” to see what would come up. I got. Some relevant highlights:

  • “A New Look at the Trickle-Down Effect in the United States Economy,” Lan, Yuexing; Hegji, Charles, Economics Bulletin, vol. 29, no. 3, 2009, pp. 1743-48: The results suggest that an increase in wage leads to a more equal income distribution. The findings also indicate that there is no trickle-down from proprietors income and corporate profits to lower income group.

    Translation: Trickle-down ain’t happenin’.

  • “Financial Imperfections, Inequality and Capital Accumulation,” Nabi, Mahmoud Sami, Economics Bulletin, vol. 29, no. 3, 2009, pp. 2388-2403: Aghion and Bolton provide a model analyzing the effect of capital accumulation on income inequality. We integrate two additional features to a modified version of this model. The first one is a costly financial contract enforcement which represents the second type of credit market imperfection in addition to moral hazard. The second one is enabling wealthy agents to undertake larger investment projects relatively to other agents. I show that inequality increases in a first stage of development and, contrarily to Aghion and Bolton (1997), remains constant or increases in a second stage (depending on the deposit interest rate ceiling).

    Translation: Even though Aghion and Bolton can write down a theoretical model showing that a trickle-down effect could happen, I can just as easily change the assumptions of that model to show that trickle-down doesn’t happen. So there.

  • “When Does Growth Trickle Down to the Poor? The Indian Case,” Basu, Santonu; Mallick, Sushanta, Cambridge Journal of Economics, vol. 32, no. 3, May 2008, pp. 461-77: A theoretical analysis and several econometric tests have been undertaken to examine whether the trickle down effect took place in rural India over a long time period. We found little evidence to suggest that the trickle down effect had occurred at all; our analysis suggests that the emergence of capital-labour substitution was primarily responsible for preventing growth from reducing poverty. The decline in poverty and a higher growth rate that took place during the late 1970s and 1980s were largely a result of government anti-poverty measures teamed with the more equitable distribution of credit and inputs to smaller and marginal farmers.

    Translation: You know how the trickle-down people say that their thing works because the rich people invest in businesses in ways that make employees more productive and thus able to get higher wages? Yeah, so, in India what happened was that the rich people invested in ways that replaced people with machines instead. Also, that reduction in poverty we saw was due to direct help and not trickle-down effects- just wanted to make sure that was clear.

  • “Do Capital Income Tax Cuts Trickle Down?” Yang, Shu-Chun Susan, National Tax Journal, vol. 60, no. 3, September 2007, pp. 551-67: Reductions in the capital income tax rate generally stimulate investment and raise the marginal product of labor and the wage rate. Hence, it is often argued that cutting capital income taxes benefits capital owners and all workers. This result, however, depends on how government manages debt to maintain budget solvency. This paper analyzes the distributional effects of capital tax cuts, where endogenous adjustments in other tax rates are precluded. When productive public investment or transfers to liquidity-constrained workers are reduced, it finds that the trickle-down effect may not hold.

    Translation: Hey geniuses, giving rich people tax breaks doesn’t help poor people if you couple the tax breaks with a reduction in public programs aimed at low-income individuals in order to keep control over your precious deficit.

  • “Endogenous Inequality,” Matsuyama, Kiminori, Review of Economic Studies, vol. 67, no. 4, October 2000, pp. 743-59: In a capitalistic society, do the rich maintain a high level of wealth at the expense of the poor? Or would an accumulation of the wealth by the rich eventually trickle down to the poor and pull the latter out of poverty? This paper presents a theoretical framework, in which one can address these questions in a systematic way. The model focuses on the role of the credit market, which determines the joint evolution of the distribution of wealth and the interest rate. A complete characterization of the steady states is provided. Under some configurations of the parameter values, the model predicts an endogenous and permanent separation of the population into the rich and the poor, where the rich maintains a high level of wealth partially due to the presence of the poor. Under others, the model predicts the Kuznets curve, i.e. the wealth eventually trickles down from the rich to the poor, eliminating inequality in the long run.

    Translation: I have a model that shows that trickle-down effects may or may not happen, depending on how I calibrate my model. Please give me tenure now.

  • “Sectoral Productivity and the Distribution of Wages,” Nord, Stephen, Industrial Relations, vol. 38, no. 2, April 1999, pp. 215-30: Policy reports suggesting that productivity growth will raise the earnings of low-wage workers are based on the concept that gains from productivity will trickle down to raise the wages of workers at the lower end of the wage distribution. The compensation and employment systems of American industry do strongly link gains in industry productivity to wage increases for most workers. However, this analysis finds that the linkage of productivity change to wage change for the workers at the lower end of the distribution is virtually nonexistent. The empirical results of this study suggest that productivity increases have no effect on the wage change of workers at the lowest 10th percentile of the distribution and widen the dispersion in industry wages.

    Translation: So you know how that whole trickle-down effect is dependent on workers getting higher wages in return for being more productive? Yeah, that doesn’t happen for poor people. Just thought you would like to know.

  • “A Theory of Trickle-Down Growth and Development,” Philippe Aghion and Patrick Bolton, The Review of Economic Studies, Vol. 64, No. 2 (Apr., 1997), pp. 151-172: Three main conclusions are obtained from this model. First, when the rate of capital accumulation is sufficiently high, the economy converges to a unique invariant wealth distribution. Second, even though the trickle-down mechanism can lead to a unique steady-state distribution under laissez-faire, there is room for government intervention: in particular, redistribution of wealth from rich lenders to poor and middle-class borrowers improves the production efficiency of the economy both because it brings about greater equality of opportunity and also because it accelerates the trickle-down process. Third, the process of capital accumulation initially has the effect of widening inequalities but in later stages it reduces them: in other words, this model can generate a Kuznets curve.

    Translation: What in the hell is a Kuznets curve? Oh, and even our theoretical model predicts that this whole trickle-down idea increases inequality before it reduces it, so we are going to specifically point out that government intervention to accelerate or replace the trickle-down process can be helpful.

Hopefully you get the idea…if nothing else, I find this screen shot to be telling:

It is worth noting that this trickle-down idea is subtly different from supply-side economics in general, since the idea that economic growth can be achieved by lowering barriers to supply doesn’t automatically mean that the benefits of economic growth spread to everyone in a society. It is also worth noting that I am not trying to make an argument for redistribution, socialism, whatever, but I am requesting that if you want to make an argument for or against various tax policies that you do so on the actual economics merits or morals of the policy and leave bogus economic ideas out of the discussion.

In summary: We economists get blamed for enough stuff that we actually put out there and support turning out to be wrong. Please don’t blame us for things that we don’t even support, since we really can’t take any more abuse. The closest thing to a trickle-down theory that economists have is the following, illustrated by yours truly:

(That diagram went over really well at the AEA meeting, given that a lot of people were there for job interviews. I have a talent for making friends wherever I go.)

Tags: Macroeconomics · Policy

18 responses so far ↓

  • 1 Derek // Jul 30, 2010 at 4:14 pm

    Hhhmm when I scanned this article I am surprised that I didn’t see anything about Laffer…

  • 2 Justin Ross // Jul 30, 2010 at 4:39 pm

    You lost me towards the end, I think, so correct me if I misunderstand. I thought your original objection was just that people were making it sound like economists give a universal endorsement to the trickle down point, but at the end you call the very idea “bogus.”

    Agreed that there is no “trickle down theory” in economics, but you can also make it just a simple derivative of statutory versus economic tax incidence across income groups. I think the majority of public finance economists believe that most of the corporate income tax is paid for by workers and consumers, and relatively little is paid by capital owners (I know the evidence is mixed, but I think the majority of pfe’s think this is the most likely consequence). I don’t know if you would categorize this in the “trickle down” aspects or not, since the theory is not explicit enough to nail down a specific hypothesis.

    Really, the idea sounds a lot like the Laffer Curve, which I think we all accept as being true at some tax rates that are sufficiently high. A top marginal income tax rate of >90% in the mid-late 1940′s probably put us there, and cutting that rate down probably benefited people of all income groups. Note also that looking at that tax cut effects on income inequality would be a red herring to the point, unless TDT is also making a specific claim about the distribution of benefits.

    I welcome being corrected/proven wrong, as always ;)

  • 3 Rev. Pfloyd // Jul 30, 2010 at 5:22 pm

    Not only that, but I think we can all agree if the tax rate was 100%, society as a whole would be a lot poorer and a lot less productive.

    So if it works in that direction then it stands to reason that it works going backwards and that lowering tax rates makes society wealthier (to a point, which is what the Laffer Curve attempts to point out). I think “trickle-down” is a term used only as invective for what we normally understand as supply-side economics and there are plenty of economists out there that think *that* is viable.

    I think the fundamental idea can be summed up thusly: if you take too much of the wealth of the people who *create* wealth, then the economic pie will stagnate or shrink. Too much wealth redistribution simply destroys the process of wealth creation since governments don’t really create wealth themselves (though they can certainly create money, I think we can all agree that isn’t *creating* anything but paper).

    So if there is an equilibrium point then, put simply, from the highest possible tax rate on down, there is some “trickling” going on as wealth is created and the “pie” grows.

    There’s probably a much more eloquent way to say all of that, but I’m in desperate need of a nap.

  • 4 Amarsir // Jul 30, 2010 at 8:01 pm

    “Trickle down” is a pejorative term. As such, I would fully expect that any publication making mention would do so negatively. Similarly you won’t find a lot of papers on healthy weight gain by searching for the term “fatass.”

    Those who support the concept would label it “supply-side economics.” Now that may, as you mention, be an inaccurate label too. But if the point of origination is prejudicial, we shouldn’t be expecting fruitful research on it.

  • 5 Michael // Jul 31, 2010 at 12:07 am

    I agree with Amarsir; the semantics taint the analysis. The very term assumes that a great amount of something (wealth) flows generously to the rich and some insignificant, leftover portion “trickles” to the gaping, empty wallets of the poor, poor poor folks.

    It’s a very ECON101 idea, but efficiency is the yin to equity’s yang. Regardless of the direct effects of wealth redistribution, there are inefficiencies introduced by the very fact that it must be redistributed.

    Some entity must remove wealth from those to whom it was originally “distributed” and (through some framework) determine who to give it to, then somehow securely deliver it to them. As humans are not perfect, this process will become bogged down with political influences, corruption etc. and pretty soon the government will abuse its revenue collection power to engorge itself, passing on the wealth only internally.

  • 6 econgirl // Jul 31, 2010 at 1:46 pm

    I specifically left out the Laffer Curve in this discussion because, like I mention briefly above, supply-side economics is not entirely synonymous with this trickle-down thing. The main tenet of supply side economics is that economic growth can be achieved by enabling (read, not taxing) the suppliers of goods and services, but this concept doesn’t specify what parties actually see the benefits of that growth. The concept of trickle-down economics takes this a step further and posits that if the wealthy are made better off that the wealth will trickle down to the overall population.

    I think this addresses the semantics point in part as well, and from what I can tell, economists who want to talk about this trickle-down concept actually do use that terminology.

  • 7 Amarsir // Jul 31, 2010 at 2:41 pm

    Well if that’s how you’re going to define it (“improved wealth at the top -> improved wealth at the bottom”) that I’m not surprised either that economics doesn’t support it. Feudalism certainly didn’t have that result. But I think that’s somewhere between a strawman and a spin, because I don’t think you could find a reputable source – economist or otherwise – who claims it is true.

    Granted, supply side economics is also different. It states that the multiplier effect of government spending is less than the negative multiplier effect of the taxes . There’s some evidence of this. The Romer paper “The Microeconomic Effects of Tax Changes” offers some evidence, suggesting that “exogenous tax increases have a large, rapid, and highly statistically significant negative effect on output.” (Naturally the paper is far more detailed than this one line implies, including the definition of “exogenous.”)

    What we’re talking about is in between the two. The question, absent spin (to the best of my abilities) is: to what extent does the reduced GDP from a tax increase on segment A affect those in segment B? And I certainly wouldn’t offer a simple opinion on that because it depends so much on the borders of those segments. Either answer could be “proven” by shifting the definition of the targets.

  • 8 Joao Pedro Afonso // Aug 1, 2010 at 7:53 pm

    Let me see if I understand all this: Jodi claims that although economy is father to too many embarrassing ideas, trickle-down economy is not one of them. Apparently, no one with credibility in economy claims its parenthood, and the papers she could get about it are mainly critical or wishful thinking in the assumptions they made. She also told us that Trickle-Down is different from supply-side (this one with proper parents): Trickle-down would be the idea that money in the upper-class income will trickle-down on other income classes when the former feels it can win even much more money with that, while supply-side would be the idea of eliminating all the obstacles to the production of goods, provoking a wealth of product offers and raising purchasing power by lowering prices and creating jobs (Is this correct?). These two ideas are indeed different, connected only by the logic statement that money taken from the upper-class income will not be available to be invested in the production of goods, if they are inclined to do so.

    After this post, the comments are,… “yes, but…”

    Yes, it is not an economic theory, but… that’s because it is another name for supply-side, which are an economic theory (wait, didn’t we agree they are different?)

    Yes, few papers has good things to say about it but… that’s because the term has a pejorative meaning which would implicate that any mention to it “would do so negatively” (You are wrong, researchers love terms with potential pejorative meaning associated to good results… If they can shock workshops with something sounding bad which actually behaves well, they will more easily remembered by their peers; if Trickle-down Theory has still a pejorative meaning, it’s because no study was able to discover that shock value on it, so far… which means the idea received originally a pejorative name by those who thought it bogus, but is pejorative now because no study was able to show it conclusively non-bogus; In other words, it has not good results because the meaning is pejorative, it is pejorative because has bad results… unless of course, there is other name for it where the good papers appear, and “Trickle-Down” is the war name for its critics).

    The respectable (non-pejorative) name to it is supply-side (Again? Are they different or not? Maybe I was wrong in the definitions I posted above; Which one I did wrong? Both?)

    Yes, but… there is the Laffer curve (Huh?…)

    Being new to the concept (well, I’m new to almost any concept here) the first thing funny I could devised about the Laffer curve is, it is not a curve. What the idea entails is the existence of a fixed curve which defines the relation between the fiscal tax rates and the total revenue captured with it. But it is simple common sense to understand that curve doesn’t exist: since the laffer curve relies its reasoning strongly in the complex human motivations face to what society/state demands from him, the “curve” is going to depend on a lot more factors than the tax rates. Inertia or delay perception, self-sacrifice inclination, societal returns, you named, the problem is that depending on the history and conditions, the revenue values are going to be different for the same tax rates. A curve usually implies a function, and this is not. Even as a multivalued function, we can even ask if it is continuous… being the result of the sum of discrete individual decisions (people usually don’t say, “I think this tax rate is too high, I’m going to apply myself to work only 30% of my commitment”… they usually quit or continue).

    The second funny thing about the Laffer curve is that, it is about maximization of state revenue. The perspective is about the optimal tax rate where the state will earn more. This argument try to convince governments to lower taxes saying to them they will gain more… which is a kind of different from the supply-side perspective where the aim is to maximize nation wealth, even at the cost of a lower government revenue (the reason why they ask for a lighter government).

    In the end, my doubt is, why to insist to rehabilitate Trickle-Down theory? If indeed it is an embarrassing idea and was never a proper economic theory to be defended, why to object to take it from the pantheon, as Jodi did? Why so many “yes, but…”?

    PS.: I prepared this comment when there were two comments less… Sorry, I should have read those too.

  • 9 Joshua // Aug 2, 2010 at 4:56 pm

    Good post. I’ll add that pro-supply-side economists do argue that society is better off through lower tax rates for the wealthy. They will not argue that relative incomes approach equality under the system, but that isn’t what anti-trickle-down people are claiming the pro-side is arguing, either. I think you are confusing, just a tad, the real notion that is being argued.

    Pro-supply-siders argue that society, as a whole, improves with less taxation among the wealthy. This presupposes a “wealthy”, ergo they cannot hope for more equitable incomes. The ability to achieve wealth, that individual drive, is what they are hoping to maintain. But they absolutely do believe and vehemently argue that this is better for society as a whole. They argue that yes, indeed, benefits from such a structure accrue, also, to those in the middle and low income ranges. They don’t say it’s money.

    Now, I’m not one of them, but that’s their idea as I take it.

  • 10 Joao Pedro Afonso // Aug 2, 2010 at 8:20 pm

    Hmm, Joshua, I wasn’t able to understand very well the point where I made the confusion you refer. Let me clarify that I’m not doubting you, it is just,… if it were that easy to escape the confusion, I probably wouldn’t be there, yes?

    Retracing my steps, I played the two ideas from a perspective in which the wealth is distributed. Your reference to “more equitable incomes” leads me to think I overplay one of them: Supply-side aiming in producing more wealth is not necessarily concerned in wealth distribution. Was that my confusion?

    Even if that’s the case, I think any important global economic idea is going to present some concern about wealth distribution. It is valid for any society, not only for democracies: to be defended, the majority of its people must believe there must be some piece of the pie for them.

    Anyway, when you say “Pro-supply-siders argue that society, as a whole, improves with less taxation among the wealthy”, are you saying all the Pro-supply-siders (meaning, it is structural to the theory), or only some part of them? In a context where the needs of a state are fixed, less taxation for the wealthy means more for the other classes. Taking literally the concept of supply-side, bigger taxes on the normal worker will be demotivating for its work and an obstacle to production and as such should be avoided according by the theory. Inclusive, if the money he saves from taxes is enough to him to think in investing or saving, he might put it in a bank, which aggregates small savings like this in bigger capital chunks better than him. What I’m trying to say here is that the notion of removing obstacles to production in the supply-side, doesn’t translate to me automatically on less taxes for the wealthy.

  • 11 Joshua // Aug 3, 2010 at 4:01 pm

    Mr. Afonso, my comments were to the blog author, not to your comments. I’m sorry for the confusion.

  • 12 Joao Pedro Afonso // Aug 3, 2010 at 5:11 pm

    Oops, I’m the one I’m sorry. Forgive me!

  • 13 lenin // Aug 6, 2010 at 7:49 pm

    Wikipedia is not considered, in the science community, as a reliable source of information… I recommend you to make a better research to give more ground to your affirmations

  • 14 Quora // Oct 25, 2010 at 3:23 pm

    Is there any hard empirical evidence to support “trickle-down economics”?…

    “Trickle-down economics” isn’t economics. The term is political in origin (and usually used pejoratively). Thomas Sowell, the iconic conservative economist, has argued that literally no economist has ever actually made a trickle-down argument. Here…

  • 15 GeorgeWBush // Jul 29, 2011 at 4:05 am

    Hi lenin. Been awhile. We should hang out again!

    She cited 7 journal publications, after mentioning wikipedia. Did you miss those?

  • 16 An Overdue Retort « An Erudite Woman // Dec 21, 2011 at 5:09 pm

    [...] among economists that it does not work. It is not even a theory economists as a discipline support. Also, since we are talking viable economic theories, inform us please of the trickle up poverty [...]

  • 17 Trickle-Down Economics and the Horse Business | Life in the "ManeStream" // Nov 14, 2012 at 12:31 am

    [...] theory of economics that we’ve been hearing about since the 1980s without any indication that anyone actually benefits other than, you guessed it, the super [...]

  • 18 Pat // May 7, 2013 at 9:55 am

    Trickle down not difficult to understand, or explain using women as it’s primary example.
    Long suffered from education, what choice but trickle down, and with it, still only 3/4 of what men earn – also trickle down!

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