The Best Way to Spur Growth? Help the Poor, Not the Rich
“Trickle-down economics” is a term liberals use when they want to disparage tax cuts for the rich. So on Nov. 9, when Fox News anchor Maria Bartiromo asked Secretary of the Treasury Steven Mnuchin at an Economic Club of New York luncheon, “Do you still believe in trickle-down economics?” the prudent answer was obvious: “Of course not, Maria. That’s not what the Republican tax plan is about at all.”
Instead, Mnuchin said, “Uh, uh, I do.”
To be sure, Mnuchin is gaffe-prone. He was last spotted on Nov. 15 happily gripping a big sheet of uncut dollar bills while his wife, actress Louise Linton, struck a Cruella de Vil pose beside him. As the journalist Michael Kinsley once said, a gaffe is when a politician tells the truth. And the truth is that Republicans have gone all in on the notion that if they pour tax cuts onto the very rich, the benefits will flow down to the mere rich, and from them to the middle class, and finally to the poor. Like a Champagne tower at a swanky wedding reception.
There’s a reason trickle-down is suddenly trickling from everyone’s lips. The Urban-Brookings Tax Policy Center calculates that the Senate’s version of the Tax Cuts and Jobs Act would give the biggest benefits to people just below the top 1 percent of incomes in 2019 and 2025, measuring benefits as the percentage change in each group’s after-tax income. By 2027, as some of the law’s provisions expire and others remain, the top 0.1 percent would be the biggest beneficiaries, the center says. (To be fair, this preliminary calculation doesn’t take into account potential economic growth effects from the tax changes.)
People on the left have been ridiculing trickle-down since before the term existed. John Kenneth Galbraith, the Harvard economist who served Democratic presidents from Roosevelt to Johnson, wrote in the New York Review of Books in 1982 that trickle-down is “what an older and less elegant generation called the horse-and-sparrow theory: If you feed the horse enough oats, some will pass through to the road for the sparrows.”
But just because trickle-down economics is easy to make fun of doesn’t mean it’s wrong. In fairness, one must seriously consider the possibility that society as a whole will benefit from a tax policy that seems tailor-made to benefit the rich.
Stripped of its pejorative label, trickle-down economics is based on the reasonable idea that cutting taxes on capital will lead to more investment in capital—industrial machinery, factories, office buildings, computers, software, patents, etc. Capitalists, of course, will be the immediate winners. But the trick in trickle-down is that ordinary workers who’re equipped with more and better capital will become more productive, hence more valuable to their employers, and will start to get paid more. A rising trickle will lift all boats.
Another branch of trickle-down is about labor rather than capital. It says that cutting income taxes on rich entrepreneurs so they keep more of what they earn will induce them to work harder, invent more, start more companies, and hire more non-entrepreneurs. If this sounds familiar, that’s because the trickle-down school is pretty much the same as the supply-side school, which focuses on boosting growth by raising the supply of inputs (labor and capital) rather than stirring up more demand for goods and services. David Stockman, President Reagan’s budget director, told the journalist William Greider for an article in the Atlantic Monthly in 1981, “It’s kind of hard to sell ‘trickle down,’ so the supply-side formula was the only way to get a tax policy that was really ‘trickle down.’ Supply-side is ‘trickle-down’ theory.”
On Thanksgiving weekend, nine prominent conservative economists released an open letter to Mnuchin that mentioned neither supply-side nor trickle-down but did argue that the GOP plans would boost U.S. economic growth for at least a decade. The economists argued that cutting the corporate tax rate to 20 percent, plus allowing for full and immediate expensing of investment in new capital, would increase business’s appetite for capital by 15 percent. That, they said, would increase the size of the economy in the long run by 4 percent. If all of the increase happened in one decade, that would mean a boost to economic growth of 0.4 percent a year. They estimated the actual boost at 3 percent—or 0.3 percent a year—because the House and Senate bills contemplate ending immediate expensing after just five years.
I ran the nine economists’ scenario past Alan Auerbach, a leading tax economist who’s a professor at the University of California at Berkeley. He’s respected by both sides in the debate. (Kevin Hassett, the chairman of Trump’s Council of Economic Advisers, cited research he once did with Auerbach in defending the GOP tax plans in October.) About the economists’ prediction of a big increase in demand for capital resulting from the tax breaks, Auerbach says, “That’s on the high end of empirical estimates.”
For argument’s sake, let’s say that businesses really do decide to invest like crazy. Since the U.S. savings rate is too low to finance all the predicted investment, the funds would have to come from abroad. (That, incidentally, would cause an increase in the trade deficit—a consequence the Trump administration hasn’t acknowledged.) The conservative economists predict the U.S. would be able to attract foreign funds without a big increase in U.S. interest rates, which would chill growth. “I’m not the world’s expert on capital flows,” Auerbach says, “but they’re making assumptions on the speed and size of capital flows that may not be what mainstream international economists would agree with.” Bottom line on their plan: “I would say it’s optimistic.”
Things get hairy fast when economists start picking over one another’s work. Douglas Holtz-Eakin, president of the American Action Forum and one of the letter writers, says he’ll “agree to disagree” with Auerbach on some points. He says the group wrote the letter because “we wanted people to understand that the desire for pro-growth policy was not based on ideology. We wanted to emphasize the evidence and reason.”
Then again, you don’t need a Ph.D. in economics to see that something’s wrong with trickle-down theory. If it were true, inequality would be self-limiting. As soon as the rich started getting richer, wealth would cascade like the Niagara down to the benighted lower classes. Instead, the gap between rich and poor keeps growing.
Galbraith, in 1982, pointed out the asymmetry of trickle-down theory, which contends that poor people don’t work more because the safety net is too comfortable, while well-off people don’t work more because their taxes are too high. Mischievously, he described trickle-down theory as follows: “The poor do not work because they have too much income; the rich do not work because they do not have enough income. You expand and revitalize the economy by giving the poor less, the rich more.” That kind of says it all.
The U.S. could learn from other nations’ experience. The International Monetary Fund found in a 2015 study that when the bottom 20 percent of a nation’s population increases its share of national income, stronger growth follows on average within five years. Brazil is a good example, says Era Dabla-Norris, one of the study’s authors. Brazil helped its poor with the Bolsa Família program—financial aid to families that get their kids educated and vaccinated. Even fast-growing China fits the pattern, Dabla-Norris says. True, inequality in China grew because a bunch of people became millionaires and billionaires. But the standard of living among the poorest improved markedly, and that helped the overall economy, she says.
The case for trickle-down in the U.S. is that companies would love to expand their businesses but are holding back because they don’t want to have to pay so much in taxes. That doesn’t jibe with the results of a Bank of America Merrill Lynch survey this year, which asked companies what they would do if they were allowed to repatriate foreign-held profit at a reduced tax rate. Capital spending came in fourth—behind debt repayment, share repurchase, and mergers and acquisitions.
On Nov. 14, Gary Cohn, the director of Trump’s National Economic Council, was onstage at a Wall Street Journal event when a Journal editor asked the assembled chief executives if they planned to invest more if tax reform passes. Few hands were raised. Cohn seemed taken aback. “Why aren’t the other hands up? Why aren’t the other hands up?” he asked. Excellent question, Mr. Cohn.