People talk about it from time to time – reducing taxes for the wealthiest Americans will improve the lives of those below them in the socioeconomic ladder. They say these higher-bracket tax cuts will end up creating more jobs, increasing wages for the typical employee, and drive overall economic growth. This is the gist of the infamous trickle-down theory, which has clearly remained a theory to this day. Not only is it unsupported by evidence but it’s also pretty easy to refute with plain and simple logic.
Here are five reasons trickle down economics simply doesn’t work based on the scenario that followed the odious 1982 Raegan tax cuts:
It does not spur economic growth.
That the economy grew more rapidly after the 1982 tax cuts, even reaching 7.3% in 1984, is unquestioned. But remember that as the tax breaks continued from the Raegan to the Bush Sr. administrations, growth began to slip into the negatives, especially at the height of the recession in 1991. Also, it was in the 1950s when growth rates were the highest – when the top tax rate was 91%. Generally, there appears to be no significant connection between the top tax rate and the GDP growth rate, which have a correlation coefficient of 0. 03.
It does not increase people’s income.
In the mid-1960s and early 1980s, tiny peaks could be seen in median income growth, which is a good sign in terms of how the average American household was doing. However, it should be noted that income also decreased following the late 1980s tax cuts, and there was remarkable growth once taxes were increased by 1993.
Indeed, the top tax rate was 70% when the median income drop was the steepest at 3.3% in 1974. But note that this rate did not change in the year in 1974 when median income growth was the highest at 4.7%. Again, looking at the 0.6 correlation coefficient of the two measures, it is clear that they are unrelated. And with a positive coefficient yet again, we know that income had increased, albeit negligibly, when taxes were higher.
It does not lead to wage growth.
Average hourly wages did rise in the 1980s after the initial Reagan tax cuts (although this was two years after the cuts were effective). But no differently from GDP growth and median income growth, there was a drop in hourly wages after the tax cuts of the late 1980s, and steeply rose after the 1993 tax hike. Moreover, wages increased to a minimum level of 1% and often a lot more the entire time when the top income tax rate was 91%. Truth is, it was only in 1972 when wage growth occurred at a rate under 1%. But reviewing the 19-year study period when the maximum top tax rate was 50%, it can be seen that there were less than 1% wage increases for 8 years. Therefore, it looks like hourly wages increased more at a time when taxes were higher. The correlation coefficient is 0.34, showing a hint of positive dynamics between more taxes for the wealthy and higher hourly wages.
It does not create jobs.
There was a drop in unemployment between the period of 1954 and 2002, which is essentially job creation. Again, though the top tax rate followed a downward pattern during this time, it’s surprising that yearly unemployment changes didn’t create a trend. And while the biggest increase of 2.9% happened in 1975 – a time when the top marginal tax rate was 70% – most of the biggest drops in unemployment took place when the top rate was 91%.
The mixed results do not sit right for those who view tax breaks for the wealthiest as a job growth driver. The two variables have a correlation coefficient of 0.11, which simply means that the number of jobs increased as top tax rates decreased. This trend is negligible though, so no relationship could be established.
The theory is purely based on assumptions.
Perhaps the wrongest thing about trickle-down economics is that it is founded mainly on assumptions. It assumes that savers, investors, and business people, will use their extra funds from tax breaks to improve businesses. Or that investors will make more investments, lending will increase, and business owners will not hesitate to spend for their operations and hire employees. Or that all of these improvements will be felt by the lowliest workers and that they will spend their wages to boost demand and economic development. In any case, assumptions are never reliable, especially for decision-making.