Trickle-Down Theory

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21 Aug, 2024

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Trickle-down theory is an economic strategy where taxes levied on the high-income group are curtailed. The theory claims that the increase in wealth will trickle down into lower economic sections in the form of increased investments and employment. As a result, the entire economy gets a boost.

This theory is based on the belief that huge corporations, wealthy individuals, entrepreneurs, and investors would reinvest tax savings to generate more employment opportunities. The critics of trickle-down economics believe that tax cuts for affluent individuals and corporates adversely affect the economy by raising inequality.

What Is The Trickle-Down Theory ?

The trickle-down theory is a political strategy. Governments reduce taxes for wealthy individuals, investors, business owners, and large corporations, anticipating increased economic activities and job creation.
The word trickle-down was first used by a comedian, Will Rogers—when he commented upon US president Hoover’s tactics during the Great Depression.
During the 1980's recession, Arthur Laffer proposed trickle-down economics to the Reagan administration. He recommended a reduction in government tax rates and claimed it would increase the government’s revenue.
In the fashion industry, trends created by affluent individuals trickle down to the middle-and lower-income groups who purchase affordable versions of the same style.

Trickle-Down Theory Explained

The trickle-down theory is a political stance—it is an expansionary policy that is applied to the upper class—wealthy individuals, investors, and large organizations. The government reduces taxes on income, dividends, and capital gains. Also, to achieve the trickle-down effect, governments relax regulations on the high-income group.

Many economists believe that rewarding the affluent sections of the society increases their wealth—that this wealth trickles down to other economic sections in the form of business expansion and increased employment as per the trickle-down theory in economics.

The term can be traced back to American humorist Will Rogers who joked about the measures adopted by Herbert Hoover—at the time of the Great Depression. Later, during the 1980's recession, Arthur Laffer proposed trickle-down economics to the Reagan administration. Laffer was an American economist and advisor.

Laffer recommended a reduction in government tax rates and claimed it would increase the government’s revenue. He formed a bell-shaped curve known as the Laffer curve to prove the relationship between tax cuts and increased tax revenue for the government.

As a result, the US marginal tax rates were brought down from 70% to 28%—between 1980 to 1988. Also, between 1980 and 1988, the federal revenue went up from $517 billion to $909 billion—due to the trickle-down effect.

Trickle-Down Theory In Fashion

The trickle-down theory of fashion plays a major role in the fashion industry; fashion trends and style statements are created by affluent individuals. The middle-and lower-income groups follow these trends by purchasing affordable versions of that style.

In the late nineteenth century, sociologist George Simmel introduced the theory to the fashion world. Authors Veblen, Spencer, and Grosse observed styles trickling down from affluent sections to lower sections of the economy. However, in 2003, Carter rejected the idea by claiming that the trickle-down concept is an organized political concept and that its application to the disorganized fashion industry is irrelevant.

In the 1960s, trickle-down fashion was criticized for class discrimination. Later, in 1985, McCracken tried revitalizing this concept by proposing a gender-based trickling-down of fashion trends. He explained that as per the trickle-down theory of fashion, women determined men's fashion trends; however, his thoughts were not considered very practical.

Also, in 2004, Cook and Kaiser stated that fashion trends trickle down from adults to teens and children.

Examples

Let us look at some examples to understand the practical application of the theory.

Example #1

American President George Bush implemented the Jobs and Growth Tax Relief Reconciliation Act of 2003. It was an attempt to revive the US economy amidst the 2001 recession. The policy offered tax relief to 136 million US taxpayers, including business owners, senior citizens, families, and employees.

The Bush government implemented the following trickle-down policies:

Increase in per-child tax credit from $600 to $1000 to benefit 25 million eligible families.
19% reduction in federal income tax for a family of 4 members with a total income of $75000.
96% tax cut for the family of 4 with a total income of $40000.
An average tax reduction of $1401 for 12 million senior citizens.
An average tax cut of $2209 for 23 million small business owners.

However, trickle-down economics did not produce results in the real world. Instead of the expected reduction in recession, inequality levels rose across America in 2005. The bottom fifth experienced only a 6% growth in their after-tax income. Meanwhile, the the top fifth marked an 80% increase in their after-tax income.

Example #2

In 1981, Ronald Reagan took charge; he came up with Reaganomics —a unique four-point economic plan. The idea was to control stagflation by bringing down tax rates, relaxing government regulations over businesses, and curtailing government spending.

In hindsight, Reagan’s trickle-down effect failed. The tax savings offered to the rich did not lead to job creation. The savings were accumulated, and the rich became richer.

The policies created a wide divide between the wealthy and economically challenged sections of the US.

Even though many policymakers or economist may argue that the rich and wealthy help in promoting free market and spending habits, which help in economic development through better distribution of income, the flow does not take place without intervention from the government. Critics also argue that the wealthy community get various benefits that tend to distort the economic balance. This can be avoided only with reduction of taxes on the poor. Then again, if tax cuts are implemented for big corporations, they may try to buy back their company stocks and hoard wealth.

Therefore, an economy can grow due to various reasons, in which this theory of trickle-down may play a small role. The country’s monetary policy, changes in the interest rates implemented by Federal Reserve, trade and commerce as well as foreign investments etc influence economic development to a great extent.

Trickle-Down Theory Vs Trickle-Up Theory

The two above concepts in economics are incontrast to each other even though both describe the distribution process of economic benefits and wealth in the society. Let us study the differences between them in details.

The trickle-down theory in economics suggests that the wealth and benefits received by the rich will eventually flow down to the less wealthy ones whereas the latter suggests just the opposite situation.
The former encourages giving tax cuts and other benefits to the wealthy to encourage them to spend more, which will reach the less fortunate ones and promote economic equality, but the latter encourages giving benefits to the middle and lower-income sections of society to uplift them.
Economists who support the former believe that the rich will promote economic growth through better investments and job creation. This will lead to better wage levels in more opportunities for everyone. But in case of the latter, supporters argue that direct investment for the less fortunate of the society less enhance the situation faster and better, leading to rise in demand, income levels and economic growth.
Critics of the former say that the wealthy will enjoy better benefits, leading to their development without significant changes for the middle and lower class whereas the ctitics of the latter say that due to betterment of the less fortunate community, the wealthy and big corporations my experience reduced growth and investment.

Thus, the above are some important differences between the two cases.

Frequently Asked Questions (FAQs)

What is the trickle-down theory?

The trickle-down economics concept claims that reducing taxes on wealthy individuals and large organizations will trigger the economic growth of a nation. The theory assumes that an increase in wealth for affluent sections will trickle down into other economic sections—in the form of increased investments and employment.

Who invented trickle-down economics?

American humorist Will Rogers introduced the phrase 'trickle-down' as a one-liner. Rogers joked about President Hoover's actions during the Great Depression.

Does trickle-down economics work?

The trickle-down theory is not very practical. Lowering taxes levied on the rich does not guarantee a transfer of benefits to the poor. Instead, it will lead to income inequality. This is because it is not necessary that the money saved on taxes will be reinvested in the business to create more job opportunities.

What is the opposite of trickle-down economics?

The opposite of trickle-down economics is trickle-up economics. It is generally considered more effective since, when the taxes are reduced for the lower-income class, it directly increases their income and purchasing power, accelerating consumer spending—promoting overall economic growth.