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Government "Stimulus": The Real Trickledown Economics

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Tags Taxes and Spending

02/14/2018

In the media and among pundits use of the term trickledown economics is common. Reportedly first used in the 1930s by Will Rogers, the expression was prominently adopted as a pejorative description of what is more appropriately called supply side economics, by those who opposed Ronald Reagan’s 1981 tax cuts.

The implication of the term, when used to describe Reagan’s plan, was that these cuts were designed to initially benefit wealthy businesses and high-income taxpayers who, in turn, would take the revenues from those cuts and go out and spend it (probably on yachts and private airplanes) which in turn would end up benefiting middle and lower income people (those who build airplanes and yachts). Hence, the money would “trickle-down” from the wealthy who receive the tax cuts to the rest of society. The expression is currently being used by opponents of the recent tax reform/cut plan passed by Congressional Republicans and signed into law by President Trump.

The fact is that, as a description of supply side tax policy, “trickledown economics” is completely inaccurate. Changes in a tax code that are rooted in supply side economics are about enhancing economic growth by changing incentives to work, save, and invest. Hence, all supply side tax reform plans focus on reducing tax penalties on productive activities.

Marginal tax rates on personal income are reduced in order to encourage work effort and investment in human capital while rates on capital gains, corporate and non-corporate business income, and interest and dividend income are reduced in order to ameliorate the penalties on saving, investment, and entrepreneurship. Such rate reductions increase the returns to these activities and therefore the likelihood that they will be pursued. This means greater economic growth. The idea of money being trickled down from higher income to lower income citizens does not figure into these arguments at all and has nothing to do with why supply side tax policies have consistently proven to be so successful.

But this doesn’t mean that we should jettison the use of the phrase “trickledown economics.” In fact, it is nearly a perfect description of the brand of economics that guides the thinking of most of those commentators who use the term to deride supply side economics — that is Keynesianism. Keynesian economics, or the economics derived from the writings of early 20th century economist John Maynard Keynes, is in fact, a trickledown theory of how to stimulate economic growth. It should be noted that Keynesian economics was explicitly adopted by President Obama when he proposed and implemented his failed 2009 economic stimulus plan.

According to Keynesian thinking, in order to have a strong economy, what economists call “aggregate demand” cannot be allowed to fall too low. Aggregate demand is the total amount of spending in the economy. Saving is considered to be counterproductive in this model. It is, in fact, referred to as a “leakage” from aggregate demand and is to be discouraged. Because of this it is the government’s job to keep aggregate demand “strong” when policymakers deem it to be insufficient.

This is where Keynesian policy turns to a theory of trickledown economics. In order to stimulate aggregate demand, Keynesians argue that the government should barrow money from the private sector, increasing budget deficits and public debt, and then spend it, through government programs that are meant to increase aggregate demand. This money, after being sucked out of the private sector through increased government borrowing, will trickle back down into the economy vis-à-vis new government spending.

In the Keynesian model the money isn’t necessarily trickling down from high income to low income citizens (actually it may flow in the opposite direction) but from the government, after it borrowed it from private investors, back down into private hands. The belief is that because the government spends it all and the private sector would otherwise save some of it, the use of government trickle down will actually be a greater stimulus to the economy than leaving the money with those who earned it. Of course, more often than not the borrowed money is simply reallocated to those that have the most political clout, that is institutions, industries, and special interest groups with the strongest lobbying organizations in Washington.

The point here though, is that Keynesian economics is truly a trickledown theory. It depends completely on money trickling down from Washington into the private economy in order to stimulate aggregate demand. Over the years Keynesian economics has proven itself to be a faulty theory. It has never worked and in fact cannot work to improve the economic well-being of society. On the other hand, Keynesian trickledown economics has worked well in providing a pseudo-scientific justification for transferring wealth from the private sector to the government and its favored special interest groups — General Motors, Chrysler and the big banks are just a few of the more recent examples.

Roy Cordato is Senior Economist and Resident Scholar at the John Locke Foundation.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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