Trickle-Down Economics: Four Reasons Why It Just Doesn't Work

By Mehrun Etebari
July 17, 2003

We've all heard the claims that cutting tax rates for the richest Americans will improve the standard of living for the working class. Supposedly, top-bracket tax breaks will result in more jobs being created, higher wages for the average worker, and an overall upturn in our economy. It's at the heart of the infamous trickle-down theory.

The past 40 years have seen a gradual decrease in the top bracket's income tax rate, from 91% in 1963 to 35% in 2003. It went as low as 28% in 1988 and 1989 due to legislation passed under Reagan, the trickle-down theory's most famous adherent. The Clinton years saw the top bracket hold steady at a higher rate of 39.6%, but under the younger Bush's tax-cut policies, the rich are once again paying less. The drastic change in tax policy that has taken place since the early 1960s gives us a great opportunity to study and evaluate the claims that lower taxes for the rich translate to more wealth for the average American.

We can compare changes in the top tax rate with the real GDP growth rate (a measure of the growth of the entire U.S. economy), and three measures of how life is for the average working American: annual median income growth, annual average hourly wage growth, and job creation. If cuts for the rich were really the magic elixir for the economy and the middle class that the Republican consensus claims it is, we would see an increase in the four indicators whenever the tax rate dropped. However, this is not the case. Such a trend occurs sometimes, but the opposite happens at other times!

Let's look one by one at comparisons of key economic indicators to the top tax rate.

1. Cutting the top tax rate does not lead to economic growth.

tax_gdp_1.gif


This graph shows the fluctuations of the real GDP growth rate over the period, indicating the performance of the U.S. economy as a whole. It is true that growth increased drastically after the 1982 tax cut, reaching as high as 7.3% in 1984. However, as the Reagan-Bush, Sr. administrations went on and taxes for the rich were slashed even further, growth fell to negative levels during 1991, at the heart of the last recession. And, two of the three years with the highest growth were during the 1950s, when the top tax rate was 91%. Overall, there seems to be no close relationship between the top tax rate and the GDP growth rate, and statistical analysis backs this up: the correlation coefficient between the two variables is 0.03, meaning that there is essentially no connection. (If tax cuts were strongly related to GDP growth, we would see a coefficient close to -1.) So much for upper-class tax cuts boosting the economy; now it's on to median income growth.

2. Cutting the top tax rate does not lead to income growth.

tax_inc_2.gif


Again, we see inconclusive evidence for the power of tax cuts. We do see small peaks in median income growth, a good measure of how the average American household is doing, after top-bracket tax cuts in the mid-1960s and early 1980s, but we also actually see income decreases after the tax cuts of the late 1980s, and strong growth after the tax increase of 1993. It is true that in the year with the worst median income decrease (3.3% in 1974), the top tax rate was 70%. However, it was also 70% in the year with the highest median income growth (4.7% in 1972)! Once again, the lack of connection between the two measures is backed up by a correlation coefficient near zero: 0.06, to be exact. And yes, yet again, the coefficient is positive, indicating that income has gone up slightly (though negligibly) more in years with higher taxes. Two strikes. How about hourly wages?

3. Cutting the top tax rate does not lead to wage growth.

tax_wage_3.gif

Not surprisingly, we have mixed results yet again! Growth in average hourly wages did increase during the 1980s following the first Reagan tax cuts, albeit two years after the cuts took effect. But, just like GDP growth and median income growth, hourly wages decreased following the late 1980s tax cuts, and spiked upwards after the 1993 tax increase.

Furthermore, wages grew at a level of at least 1%, and usually much more, all throughout the period when the top income tax rate was 91%. In fact, it isn't until 1972 that we see a wage growth rate of less than 1%. However, if we look at the 19 years of the study period when the top tax rate was 50% or less, we see that 8 of the years saw an increase in wages of less than 1%. Thus, it seems that hourly wages grew more when taxes were higher - indeed, the correlation coefficient is 0.34, indicating a mild positive relationship between higher taxes for the rich and higher hourly wages. This finding flies in the face of the conservative theory. As if that's not enough, now let's see about what President Bush claimed would be the biggest result of tax cuts - job creation.

4. Cutting the top tax rate does not lead to job creation.

tax_emp_4.gif

Here, we see the change in the unemployment rate laid against the top tax rate from 1954 to 2002. Thus, negative values signify a decrease in unemployment -- in essence, job creation. Once again, while the top tax rate trends downward over the period, the annual change in unemployment doesn't seem to trend at all! Although the largest increase (2.9%) did occur in 1975, when the top marginal tax rate was 70%, three of the four largest decreases in unemployment occurred in years when the top rate was 91%. The mixed results do not bode well for those who see tax cuts for the richest as a sparkplug to incite job growth. The correlation coefficient between the variables here is 0.11 -- meaning that there have been slightly more jobs created in years with lower top tax rates, but this pattern is negligible -- nowhere near strong enough to signify a relationship.

So, can you tell what our conclusion is yet?

Overall, data from the past 50 years strongly refutes any arguments that cutting taxes for the richest Americans will improve the economic standing of the lower and middle classes or the nation as a whole. To be sure, the economic indicators examined in this report are dependent on a variety of factors, not just tax policy. However, what this study does show is that any attempt to stimulate economic growth by cutting taxes for the rich will do nothing -- it hasn't worked over the past 50 years, so why would it work in the future? To put it simply and bluntly, Bush's top-bracket tax cut is an ineffective attempt at stimulus that will not cause any growth -- unless, of course, if you're talking about the size of the deficit.


Showing 7 reactions

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  • commented 2016-07-25 22:37:28 -0400 · Flag
    Here is how trickle down economics really works…

    - Boss, I really like your car.
    - Thanks. Keep working really hard and I will get an even better one next year.
  • commented 2016-05-19 21:31:37 -0400 · Flag
    Trickle down at home then being that most of us didn’t understand that graph crap.

    If the parent don’t make money can they give their children an allowance?

    Pretty simple to me
  • commented 2016-05-04 16:53:16 -0400
    That’s a very dry account of why it doesn’t work. Trickle-down economics doesn’t work for many reasons, but here are a few:

    The businesses and corporations need to people to buy their goods. The more money the more people have the better the businesses and everyone else will do. Cutting taxes just for the very wealthiest doesn’t achieve that

    Similarly, proponents of trickle down will argue for reduced benefits/welfare for the poor. Their reason for doing this is to reduce the tax burden that they feel lies unfairly on them. But if you take money away from people on benefits you are taking money out of the economy and making the country poorer. Every nation that has introduced a welfare state has seen a huge boom in economic growth.

    Trickle-down economics has led to increased inequality. Even since the 2008 global crash the very wealthiest have more than doubled their incomes while the rest have seen either very moderate rises or real term falls in their salaries. The rich are now so rich that the things they buy – sports teams, multimillion-dollar artworks, increasingly costly houses, etc – have no trickledown effect.

    The Panama Papers have exposed a tiny part of the trillions of dollars the very wealthiest hide from the state already and have been doing for years. When a conservative/right wing government tells us that there is no money to spend on the majority there would be if they took collective action on tax avoidance.

    Higher taxes on the rich increase the wellbeing of all. After WWII the rich in the US and the UK were paying around 98% tax and that allowed us to rebuild our wartorn economies and create exemplary models like the welfare state and the National Health Service in the UK. Everybody realised at that time the debt owed to the many who had fought and died and they were willing to look after them. Also people had a powerful voice through collectivism, the trade union movement meaning that both left and right wing governments had to do what was in the interest of the majority. This was the Postwar Consensus.

    From then on there was a period of exceptional growth, but it was gradually eroded by reducing the top rate of tax. Under Reagan and Thatcher a programme of deregulation allowed the financial services industry ever more power. Privatisation took assets away from people and concentrated wealth into the hands of a few oligarchs whose wealth ensured they had the ear of government. This was and always has been trickle up and it continues to this day under every right wing government.
  • commented 2016-03-26 19:16:38 -0400
    Well its obvious, this website doesn’t understand trickle down theory at it’s core. How? this is because he looks at graphs and makes conclusions without really knowing what it shows. Let me explain why the so called"1%"ers are funding most ideas in the nation. Most people don’t realize is that the rich don’t have a giant vault filled with gold coins and cash like in duck tales. Even Bernie Sanders quotes them as being on wall street. Well where else do they put there money? The bank, bonds, buying actual items. All of these are investments, votes as I call it, in well researched companies because when someone decides to invest, or buy an item they are giving them a chance to expand and keep making their product creating jobs. Now you might say that the bank isn’t an investment. Well if you have researched how a bank stays in buisness is because they loan out most of their deposits, this is called fractional reserve banking and it;s done every day, banks (rich peoples deposits) investing in new idea’s thus creating new jobs. You may now complain “Why are the rich getting richer then?!??!?” well this is simple; When you invest your money in a bank it comes with a certain amount of risk, banks may have a very low risk but they have a very low return on investment too, but on the other hand, loans, and certain stocks have a much higher risk and can serve to give very high return on investments. Now, I would like for you the reader to imagine you’re competing to get a spot in a very special club. This club is called the 1%er’s club. You see since there will always be growing inflation that is a given, investing a very much a must to retain membership in the 1% club. Since we know that big risks lead to potentially big outcomes, the ones that invest the smartest and receive the most from these investments will become members of this club, kicking out the old members who may have performed well before but may be on a bad investment streak, this is a huge flaw in the 1% argument, you see when you have new members constantly replacing old members the quota for admissions in the new club gets higher over time, this is why we see the increasing real wage for the 1%er’s. While those high members are competing for a spot, the rest of the 99%ers are all left still competing but in a much bigger bracket. Because of the fact that the one percent are always the best of the best getting better, the 99 percenter’s have to be the rest of the great adequate and bad investers. this creates an almost medium for real wages because the quota never changes the bar is always blocked by the members who cant do as well.
  • commented 2016-03-11 04:42:22 -0500
    Trickle down doesn’t work. It only increases the wages of company executives. Put simply, the more money put to the bottom line will end up in executive level bonuses and stock dividends. When a company does well, the last thing a company is looking to do is increasing wages because whatever the real cause of increased profits, the company will default to “why would we increase wages when we did so well with them at their current levels?”
  • commented 2016-03-07 10:56:43 -0500 · Flag
    Your graphs make no sense and are as accurate and relevant as the “unemployment” rate.
  • commented 2016-02-25 00:06:37 -0500 · Flag
    Interesting. How about citing the data source and any peer-reviewed analyses for deeper exploration please? Thanks.

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