Trickle up economics---A new theory

Great Debates
1

I was listening to NPR this morning and they mentioned how the Dems parked a Lexus in front of the Capitol yesterday to demonstrate how much money the richest 1% would get from Bush’s tax cut (i.e., enough to buy a new Lexus each year). In response, Bush’s Secretary of the Treasury said that those Democrats clearly don’t understand economics because the idea is that the rich won’t spend it, they’ll invest it, which is why it will help not just them but everybody, including the poor. Trickle down economics rears its ugly head once again!!!

So, I was wondering…Many people seem to hold such reverence for this theory although I get the impression that the evidence for it is pretty non-existent. So, why not the trickle up theory of economics: You give tax breaks to the poor and lower part of the middle class, they’ll go out and spend it, which will in turn put more money in the hands of those who make the goods they buy, who can then go out and invest it (or spend it). And, there you have it…Everybody benefits; Even the rich end up with second-order benefits! Why is this theory not held in as high esteem as trickle down theory?

As further evidence of this, I note that my company has currently pegged our R&D budget to a percentage of gross revenues. This means that if you give a tax cut to people who don’t go out and spend it on our products but “invest” it instead, our own investment in R&D won’t go up a dime (at least from these first-order effects). However, if you give it to people who do go out and spend on our products, our R&D budget and thus some real honest-to-goodness investment will go up!

Anyway, I was just wondering…Can anyone actually justify “trickle down” economics as being any better at raising the general economic level than “trickle up” or is the advantage of trickle down simply that more of the effects go to those with money and power who dominate the political process and our political discourse?

2

By the way, here is a link to an NY Time article about what Treasury Secretary O’Neill said:

http://www.nytimes.com/aponline/national/AP-Bush-Taxes.html

(To his credit, he did appear to at least acknowledge the “demand” side of the equation of giving some of the cut to people who would spend it.)

3

I have yet to read an economist who thinks that the widening gap between rich and poor and a shrinking middle-class is good for an economy.

4

By the way, the idea of trickle-up economics has been around along time, it inspired the negative income tax plan currently in use. By giving working families extra money as a direct tax bonus, currently up to 3800 dollars, it gets spent immediately on necessities like car repairs and clothing, which keeps the economy afloat.

5

Trickle-DOWN economics is, unfortunately for the democrats, a very viable economic model. In fact, it’s a natural consequence of capitalism; when you subvert capitalism, you lose the effect of the trickle-down. When the wealthy are allowed to keep most of their money, they spend and invest it. The things they buy are made and sold by middle class merchants. The things in which they invest employ middle and low class workers. The middle class merchants, who now have more money, buy goods and services from lower class people. Rinse and repeat. This is sort of a “state of nature” situation. When you start taxing people rediculously and diverting the money in ineffecticve and beaurocratic social programs, money is wasted and the economy does not prosper.

I think you’re missing the point. First, if people have more money, they will buy your product. They will also invest in your company, increasing its valuation, and therefore eventually increasing your R&D budget, leading to more jobs, leading to more income, leading to more purchase power.

6

This sounds like religion to me more than anything else. Where is the proof that money given to the wealthy is more effective to the overall economy than that given to the less well off? Also, where is the proof that money put into social programs is wasted? That money also gets recycled through the economy by the same mechanisms as all the other ways of using the money that we are speaking about. [By the way, it is “Democrats” not “democrats” when you are speaking of the party rather than the system of government…A freudian slip perhaps?]

I’m not missing the point. That was why I made the comment about 1st-order effects. I admit that second order effects could cause our R&D budget to go up. However, my point is that the more direct way for us to get the budget increased is to have our revenues rise, which means the demand side. Our management has made it very clear that they aren’t pegging our R&D budget to the amount people invest in the company; they are pegging it to our revenues.

I’m not trying to claim that money to the wealthy won’t be recycled in the economy in ways that lead to more wealth being generated. It is just not obvious to me that it will lead to more wealth being generated than using that money in some alternative way (say, to give tax cuts to the poor, to invest in people through education, …). It is however fairly obvious that giving tax breaks to the wealthy is the most direct and probably most effective (although there is a little room for argument here) way to increase their wealth.

Brian B.…Thanks for your contributions, which I essentially agree with. In particular, I agree that influencing the demand side of the economy is something that has been done for a long time. In fact, the supply side theory may be newer. But clearly, there seems to be a generation of people who are growing up without questioning the validity of the idea that the best way to raise all boats is to give tax breaks to the wealthy who will then use it to invest and enrich us all. [By the way, at least for the purposes of this discussion, I guess I would have to group myself in the “wealthy” category, since my income outstrips my spending considerably and I would probably use the money from a tax break to “invest” unless I decide to make a specific commitment to spend all or part of the money to help counteract the detrimental actions of our current President, which I am seriously considering.]

7

Friedo,

Tax-based spending was the key to most of the post-war booms in Japan, Europe and America, and even Reagan borrowed money to spend for the government in the defense sector to make an artificial economic boom. Also, without safety nets, for individuals and corporations, there would be more depressions, which wipe out investment completely in some cases, and sometimes erase entire labor markets by emigration. By the way, the class system you propose exists in the so-called third world. Can you name a successful third world economy? Last time I checked, Scandanavia and Germany enjoy higher average per capita incomes than the US and higher education achievement across the board via socialized higher education, while spending much less per person on health care by covering everybody. Most successful economies do not feature “trickle-down” by giving huge tax breaks to the rich, which refutes your theory effortlessly. When most American jobs are sent overseas and we become a third world nation too, I don’t think we’ll be demanding too much more of trickle down. It would be like a renter cheerleading the rising value of the house they live.

8

The problem with a system of increasing the wealth of the rich is that a given person can only consume so much goods and services. A corporate CEO may make 400 times as much money as one of his employees but he certainly doesn’t consume as much as 400 times as many goods and services.

Moreover, investment in companies is useless, as far as trickling down goes, if wealth isn’t distributed substantially enough that the goods and services they produce will actually be consumed. A company does not pay its workers by how much investment it receives, but by how much profit it makes.

By way of contrast, let’s look at the OP’s proposal of increasing the amount of wealth in the hands of the poorer z(and also larger) class.

A poor person spends a much greater proportion of her income on goods and services than a rich person. Therefore, a much greater percentage of money put into the hands of a poor person will be spent on goods and services than money put into the hands of a rich person.

Moreover, a rich person is as likely to invest in distant markets as not. This is especially true in a country like Canada. However, poor people spending their income on goods and services are investing much more heavily in local enterprises. That creates jobs in policymakers’ own districts, serving to reduce poverty and increase growth even more, in non-inflationary sectors no less.

Putting $50 into the hands of a poor person will stimulate the local economy more than putting $50 (or even $5,000) into the hands of a rich person.

9

Incidentally, “trickle-up economics” has been tried before, under the name of Keynesianism. It was begun around the end of the Great Depression and was eventually destroyed by Nixon’s abrogation of the Bretton Woods agreement (which helped provoke the 1973 depression). It had the minor economic consequence of bringing on the longest sustained period of broad economic prosperity in history.

(In addition, the 50s had some of the highest corporate tax rates ever recorded. Despite this, it was not noted for horrendous economic crisis and collapse. Interesting…)

10

If you give money to the less well off, agreed, they will have money. But this does not positively affect the economy. It does not cause businesses to expand in order to create new jobs. An example is monetary welfare; you give jobless people money, but this does not create jobs.

It’s well known in economics that the best way to get demand to rise for any non-essential product (I don’t know what your company makes; I’m assuming it’s not a basic necessity like food or water.) is to increase the spending power of the people buying that product. If we give money to the poor, it will obviously increase their spending power and they will purchase the product. However, when investments can be made into your business increasing its valuation, that will lead to new employment, which increases everyone’s spending power. Further, the new employees are earning money, not receiving charity, which is simply a better situation to put people in.

I don’t know if you want to debate the merits of trickle-down in general or the Bush plan in particular (or both). Part of the Bush philosophy is to give very large tax cuts to the poor as well. According to Bush’s tax plan, a family with less than $35,000 income will pay $0.00 income tax. This increases their spending power, which benefits everyone.

I wasn’t “proposing” a class system. I’m saying a class system already exists. Whether classes a moral or not is a subject for a different debate. However, I do believe the best way to help the poor is to increase demand for jobs, not to hand them money. This takes longer, but I believe it a sounder economic policy for the long run.

I am also not proposing that there be no tax spending. Tax spending is important and appropriate for some things, but not others. One of the things it is not appropriate for is the direct redistribution of wealth.

I’m not familiar with Germany, but I can tell you that socialized medicine in the UK and Canada has been a disaster. (The US health system is not that spiffy either, but again, this is a topic for another GD.)

11

Do it yourself economics, gotta love it…

Trickle down: Give the money to the rich and they’ll either spend it or they will not spend it. “Not spending it”, is called, “savings”. The savings can take the form of a bank deposit, purchases of equities (directly or indirectly through a mutual fund), purchases of bonds (ditto), or purchases of commodity futures, for example.

Give the money to the middle class or lower middle class and they will either spend it or they will not spend it. “Not spending it”, is still called, “savings”. One might argue that a higher share of the savings will go to a bank, rather than a mutual fund. (Examples of net savings via the banking system include, “Paying off your credit card bill”.)

Of course FDIC insured banks can purchase bonds on their own; they still can’t purchase equities.

So, I guess the “trickle down” advocates think that a greater share of national savings should bypass those inefficient bankers. If so (and I’ve never heard this version of the argument) it would seem more effective to encourage the middle class to shift their savings into mutual funds.

Or maybe they are hoping that the rich are entrepreneurs, who will actually invest their tax windfall in an actual small business. If so, they should advocate a tax break targetted to that. Nah… that’s the plan that Clinton passed.

friedo: There are plausible arguments for cutting the taxes on the rich -empirically ungrounded ones, but at least plausible. I’ll try and get you started.

Marginal tax rates before and after Bush plan:

First ignore social security. That hurts the conservative case, since the tax tops out at about 90K.

Then, compare the Bush tax rates to the current tax rates.

Status Quo … GW Bush plan

39.6% … 35%
36 … ?
31 … ?
28 …
?
16?% …10%

(Note: many of those who pay the AMT will actually see little if any tax cut, but that’s another issue).

Sorry, I can’t be bothered to check the numbers. You’re suppose to look at that table and say OMIGOD, if a rich person works an extra hour, the Feds keep almost 40% of his wages :eek:, a higher share than people in lower tax brackets.:eek::eek: That’s a crippling disincentive to work and build America. Those paying the top rate need a tax cut the most for incentive purposes.

Then talk about how longer hours (and more intensive effort and more risk taking) for CEOs will benefit us all. Yadayadayada trickle down.

I don’t think you want to make the “consume and save” argument. Anybody will do that if they are given the funds.

12

Since poor people spend a much greater percentage of their income on goods and services than rich people, yes, it does. Even more so.

Excuse me? I’d like to see a cite for the claim that socialized medicine in Canada has been a disaster for any reason other than government cutbacks and encroaching privatization.

13

Wrong !
A “disaster” is having the worlds 34th ranked health care system in the worlds richest economy (Cuba is 36th) which, according to the WHO, is the case with the US ‘captalised’ health care system.

14

Friedo, Do you have some sort of genetic condition that causes you not to recognize the second order effects of money that goes to the less well off as opposed to money that goes to the rich? Do you think these people simply burn the money?!? They spend it for God sakes and that positively effects the economy. Furthermore, some of the other posters have presented arguments as to why this might have a greater positive effect than when the money goes to the wealthy (although I have been sticking mainly to just questioning the double standard of why money to the wealthy is considered so much more economically-positive than money to the less well off).

Are tax breaks to the poor “charity” and those to the rich not?

Oh boy…We’ve been down this road so many times before on this message board! It depends on your definition of “very large”. Bush likes to speak in percentages (as the chart on that web site so nicely illustrates), conveniently restricting the percentages to that of federal income taxes only. That way, the regressive payroll taxes, state income taxes, and sales taxes are not included and it looks really impressive…Some people whose current tax burden comes almost entirely from these other taxes will have their federal income tax drop to zero and will get a 100% cut! Yippee!!! If you want an honest analysis of who gets what from the Bush tax plan, try http://www.ctj.org/html/bush0201.htm and http://www.ctj.org/html/bush0800.htm (This organization admittedly has its own biases, but I have not seen anyone seriously challenge their numbers.)

Well, as the OP, I would say that it is very much the same debate. The point is that you are defending a system that leads to vast inequalities of wealth and income…higher than probably any other First World country and comparable in some respects to some Third World countries. I just don’t see how one can divorce tax policy from the debate about equality of wealth and income since some tax policies lead to more money going to the wealthy and some to more money going to the poor.

But, you really haven’t provided any effective evidence or arguments for this belief. That is why I consider it to be essentially religion.

15

jshore, I don’t know what your problem is, but I have not insulted you in this thread. I was under the impression we were having a debate about economic policy. Please let me know if you wish to continue this debate with me or if you wish to continue to insult me without reason. If the latter, I will choose not to participate further.

16

Sorry, friedo…I meant that genetic thing as a friendly jest, but also expressing a certain amount of frustration that you seem to disregard how money continues to circulate in some cases while considering it in others. I was just marveling at what I see as the inconsistency of this. (And, it isn’t just you…that sort of basic inconsistency seems to be very prevalent in the debate about tax cuts.) I didn’t mean to insult you.

By the way, looking back at the last couple sentences of my post, I don’t mean to imply that I disagree that creating jobs is better than handouts. What I am questioning is whether giving tax relief to the wealthy really creates more jobs than tax relief for those less well off who go out and spend that money on goods and services.

Hope that those two clarifications help.

17

Sigh. There really is no reason to have a debate on this. Sometimes it’s trickle-up, sometimes it’s trickle-down. Or, to put it another way, sometimes Capital has the upper hand over Labor, sometimes Labor has the upper hand over Capital.

As for taxes in the U.S., we should just go back to the 15/28 and capital gains taxed as ordinary income we had from 1986 to 1990. This was a good, simple, compromise. Except that today, the Democrats would never agree to two tax brackets, and the Republicans would never agree to having capital gains taxed as ordinary income.

Both sides are being bull-headed, IMO.

18

The last time trickle down was tried, the rich bought things like Mexican factories, German cars, Japanese electronics. Little benefit to the US from what I see.

19

wow…what an informed statement…as though what the “rich” (whomever they may be and however it is you define them) owe you any sort of accountability as to their spending/investment habits.

20

Not quite. “Treasury I”, the Reagan administration’s first stab at tax reform (as opposed to their earlier tax cutting effort) had identical rates for wages and capital gains. The Wall Street Journal approved, noting the accounting gymnastics done to switch income from the high tax type to the low tax type.

I had thought that this part was preserved in the 1986 tax plan. IIRC, the deal started to unravel when top rates started being increased while the cap gains rate stayed the same for high income people.

I’m not entirely sure how the Republicans (and Democrats for that matter) came to care less and less about the principles embodied in the 1986 tax reform.