Are Trickle-Down Economics a Viable Theory in Todays Economy - Research Paper Example

? Are Trickle-Down Economics a Viable Theory in Today’s Economy? by Donna Purcell Economics 02 November Donna Purcell Order# 588988 02 November 2011 Are Trickle-Down Economics a Viable Theory in Today’s Economy? What exactly does the trickle-down theory mean? Investopedia defines it as; “an economic theory which states that investing money in companies and giving them tax breaks is the best way to stimulate the economy.”1 It is further explained that, “proponents of this theory believe that when government helps companies, they will produce more and thereby hire more people and raise salaries. The people, in turn, will have more money to spend in the economy.”2 Therefore, are trickle-down economics a viable theory in today’s economy? The average person has no concept of why anyone would give huge tax breaks to the wealthy. This argument has been prevalent since the rich has taken advantage of economic freedoms to increase their profits. It seems only fair to the ordinary taxpayer that they should give back a larger share than those who are not wealthy. This theory is the basis for the progressive income tax within the United States. The government taxes the higher tax brackets when their income increases in excess. The trickle-down theory promotes that tax breaks for the higher income sectors will benefit all. The average income earner cannot begin to fathom the reasoning behind this. Looking at history and the principles of supply and demand, some economists would say that efforts should be made to increase the supply or production of goods and services. Others would argue that a slow demand for goods and services is the problem, and efforts should be made to increase demand. The 19th century French economist Jean-Baptiste Say argued that economic growth will grow naturally if you boost production. This has become known as Say’s Law. In the 19th century this was not a popular concept, as it was believed that a lack of money and lack of demand prompted bad economic times. Says also believed that “there would always be a demand for the right kind of products.”3 The principle of thought says that if people are willing to work during a downtrend economy, there must be a need for money to purchase something. Therefore, there has to be a demand that is not being satisfied. What they desire is either too expensive or not being made. Making products that are in great demand will, in turn, drive down the cost and create profits for the producer or seller. This process satisfies the need or demand and turns the wheels of the economy. In the 19th century this theory was a viable way to access the situation. Thomas Jefferson even stood by the theory. When the Great Depression began in the 1930s, some economists’ views began to change. The British economist, John Keynes, argued “that there are such things as overproduction and lack of demand, and the key is to increase demand rather than supply.”4 It was his understanding that consumer demand should be promoted instead of production, and this would create jobs and production through higher consumption. Keynes introduced many theories in order to stabilize the economy on a short-term or immediate basis. He introduced policies to adjust interest rates, which adjusted available money. He also introduced policies that encouraged government spending and taxes, which would boost demand. A major part of these adjustments were to increase taxes on the rich and reduce taxes on the poor. It was his contention that the rich would invest their money producing more products and the lower income people would more than likely spend. Therefore, the oversupply of goods would be taken care of on its own, which was the source of the problem. Keynes’ philosophy of economics continued for at least three decades. By 1970 Say’s Law began to emerge again as a viable theory. Once again, trickle-down ideas were gathering support of some economists. If we think of trickle-down economics as a catalyst to boost production, it uses Say’s Law as the key to coming out of a recession. The basic principle instills that tax breaks improve tax revenues and thus elevate production. Therefore, tax breaks to the higher income sector is a move meant to improve the overall stability of the economy. Economists who oppose this theory believe that it’s all politics and the theory is just supporting wealthy businessmen. The opposition defines it as basically “giving breaks to the rich first and hoping the benefits will eventually make their way to the working classes.”5 Opponents of trickle-down or (the supply-side) of economics see this as an off-the-wall prediction of the results. Thomas Sowell, who is a loyal supporter of the trickle-down theory, argues that the theory actually supports the working class first. It is the higher income sector that get the tax cuts, however, these wealthy investors pay workers and create jobs before they see any profits. Therefore, the workers receive the most immediate benefit from the tax cuts. It is his contention that the wealthy must spend money to make money, so their money is first spent on expenses of any business venture. John F. Kennedy supported trickle-down economics when he said, “a rising tide lifts all boats.”6 In essence this means that a growing economy benefits everybody whether you are rich or poor. It is David Madland’s opinion that it is not the “rich that leads the way to growth and prosperity. Instead, it is a thriving and vibrant middle class that shows us the path.”7 Politically the middle class is viewed as something that is created by the gains of economic growth. However, the middle class is in fact the source of economic growth, and the middle class drives a stable consumer base. The middle class encourages strong society and national conditions that promote growth. Furthermore, a strong middle class promotes innovation in entrepreneurship, produces better government and promotes education and long term investments. This will lead us back to one of Keynes’ perceptions that extreme unequal distributions of income prevent demand and reduce growth. This can be seen in a recession where incomes are stagnant or declining, credit is not readily available, and there are high levels of consumer debt. It is obvious that in order to promote sustained economic growth; the middle class must be strong and has to consume goods. It is noted that in order to grow the middle class it is necessary for their incomes to rise. These principles create trust within the middle class and trust leads to working together in business and life. It creates an optimistic outlook and offers the belief that the average person has control over their circumstances. It is very hard to convince the average person that rich and poor share the same common values. However, in a thriving economy its much easier to trust strangers in business and life when less time is spent on verifying and policing. Trusting people see the world full of opportunities. They seek out innovation, new technologies, trade and new business ideas and take more sound risks. Once again a strong middle class promotes better government by transferring the trust created into a government that is well run, has increased citizen participation, and can produce policies for the benefit of all its society. Albert Chong and Mark Gradstein developed a theory that inequality in government can have harmful effects on the quality, stability and democratic view.8 A weak middle class promotes a corrupt government and causes governing practices and institutions to become weak, therefore the structure no longer delivers for its citizens. It is also likely to cause taxpayer dollars to be wasted. So one can now see the opponents to trickle-down economics or progressives have a much better grasp of the situation. The strength lies within the strong middle class concept. There are certain characteristics of a strong middle class in America. Some of these stem from upbringing and environment, which directly affect middle class achievements. The middle class is much more likely to become entrepreneurs, set goals and strive to achieve those goals. The Kauffman Foundation report shows that 72 percent of entrepreneurs are from middle-class families. “One characteristic that stands out in the literature on the middle class is that middle-class families emphasize their expectations about the future: this means they work hard, plan ahead, and expect to save in order to attain those goals.”9 Students who attend schools where the majority of students are middle class have a much better chance of success. Capitalism cannot grow and be healthy without a healthy middle class. Trickle-down economics has dominated the scene for decades. The progressive opponents have fought for a strong and healthy middle class but so far no one has come forward with a viable advancing alternative. Looking at the current situation, President Obama campaigned against trickle-down economics but has adopted a version of trickle-down economics that has not worked. In essence a stimulus bill aimed at spending $1 trillion to grow government in the hopes that it will trickle down to help those who have lost jobs. Americans have lost 791,000 jobs in manufacturing, 681,000 jobs in professional and business services, 632,000 jobs in construction, 522,000 jobs in retail, 167,000 jobs in hospitality, and 576,000 jobs in other parts of the service industry.10 Creating jobs within these sectors would be a logical solution. . However, the democrats have proposed to spend $88 billion to increase Medicaid, which will have little effect on jobs in any of these sectors. There have also been appropriations for funding in University research grants, Energy Department labs, and the National Science Foundation. Funding has been appropriated within the health care sector as well adding a few jobs in both health care and education. It is apparent that budgets of political allies are being placed above budgets of struggling families, which constitutes the new Democratic trickle-down economics. The flat tax rate concept is starting to show up again among some Republican candidates. This concept is not popular in Congress, as it tends to favor the rich. Thus, bringing back the old debate concerning trickle-down economics. Conservative economists think that a flat tax will promote economic growth for the long term. It will lower taxes on the people who save and invest the greatest amount of their income, the higher income sector. Lowering taxes now on the rich could be very difficult given the occupying of public spaces and calling for the rich to pay more. President Obama and some members of Congress are also calling for the higher income Americans to pay more. Chuck Marr, director of federal tax policy at the left learning Center on Budget says “lowering taxes on high-income people and somehow middle class people will benefit has been there for a long time. Obviously, it hasn’t worked very well.”11 So what is the answer? In conclusion, almost half of US households pay no federal income tax because their incomes are so low or they qualify for tax breaks. Those making between $50,000 and $75,000 pay an average of 7.2 percent in federal income taxes. These statistics are from the Tax Policy Center. The Congressional Budget Office shows that the top 10 percent of households by income pay more than half of all federal taxes. Cain wants to scrap the current tax system, eliminate payroll taxes that fund Social Security and Medicaid and replace it with a flat 9 percent income tax. His plan only allows deductions for charitable contributions. Perry also proposes a flat rate but would preserve deductions for mortgage interest, charitable donations and state and local taxes. It also calls for a $12,500.00 exemption for individuals and dependents. Therefore, you could possibly make $50,000 and pay no federal income taxes. We have looked at how trickle-down economics work and how they have been a predominant theory since the 1930s. However, the progressive opponents to the theory have also supported their position through the theory of a strong middle class as being the basis for a strong economy. It has been shown through the supporting information that the trickle-down theory has not worked in the past, but that some economist still support and stand behind the theory even in today’s economy. The Democrats are relying on the fact that Americans now stand behind a centralized, top-down government and they won’t mind paying for it. Is this a viable belief?. Opponents to the trickle down theory don’t think so and believe they will suffer politically for this misconception. It does open up the renewal of the debate and the entry of new ideas on tax reform that can bring back a strong middle class economy. References Investopedia. “Trickle Down Theory.” Web 02 November 2011. http://investopedia.com/. Madland, David. Democracy A Journal Of Ideas. “Growth and the Middle Class.” Spring 2011/20. Web. 02 November 2011. http://democracyjournal.org/. McGrath, Jane. “How Trickle-down Economics Works.” The Basics of Trickle-down Economics. Web. 02 November 2011. http://money.howstuffworks.com/. McGrath, Jane. “How Trickle-down Economics Works.” Boosting the Economy: Supply Vs. Demand. Web. 02 November 2011. http://money.howstuffworks.com/. Ohlemacher, Stephen. “Flat tax renews fight on trickle-down economics.” 26 October 2011. Web. 02 November 2011. http://seattlepi.com/. Rove, Karl. “Democrats Try Trickle-Down Economics.” Web. 02 November 2011. http://online.wsj.com/. Read More