A “trickle” is a small flow of a liquid. “To trickle” means to flow in tiny amounts.
Critics of economic freedom use the term “trickle-down economics” for the proposition that the reduction of taxes and excessive restrictions on investment by the rich will result in a mere trickle of benefits to the poor. This is an argument against stimulating greater private investment and in favor of more government welfare for the poor paid for by higher taxes on the rich.
It is possible that a particular investment has a trickle-down effect. For example, if a resort hotel is built in a location in which there is much poverty, the hotel would typically create only a few jobs for the local people, leaving most of the population poor. But the trickle-down concept applies to a whole economy and to economic policy, claiming that greater wealth for the rich generally only provides a trickle of more income for the poor.
In his article “‘Trickle-Down Theory’ and ‘Tax Cuts for the Rich,’” economist Thomas Sowell states that he could not find a single economist who has ever presented a trickle-down theory or advocated a trickle-down policy. No such theory is found in current textbooks or in books on the history of economic thought. In another article, Sowell challenged anyone to name an economist who advocated trickle-down; nobody was able to find one. “Trickle down” is a straw-man perpetuated by critics of economic freedom.
Substantial reductions in the highest tax rates have resulted in both greater tax revenue and greater employment and income for all people. Government revenue rises because there is greater production and also because lower tax rates shift financial assets from tax shelters such as municipal bonds to taxable income such as stocks, in order to obtain higher returns.
A basic principle in public finance is that the effect of taxes on output and investment depends on the tax rate on additional income, the “marginal tax rate.” Supply-side economic theory says that lower marginal tax rates induce greater production and employment. The ultimate supply-side policy is a marginal tax rate of zero, so that taxes are fixed cost per year, regardless of one’s income, spending, or personal property.
The most effective way to have a zero marginal tax rate is with land-value taxation. The title holder pays a fixed amount, based on that year’s assessed land value or land rent. Both labor and economic investment get and keep their full rewards. The result is not a trickle of employment and wages, but a fountain, a gusher of economic growth, relative to the stagnant past.
Because the supply of land is fixed, much of the gains from economic expansion is captured by higher land rent and land values. Speculators then observe rising land values, and buy real estate to sell at a higher future price. The speculative demand adds to the demand for actual use, and, as happened in 2006-2007, real estate becomes unaffordable, and then we get a severe recession as in in 2008-2009.
What the critics of markets miss is that, with the current public finance system, the reason that economic growth and trade fail to raise wages by much is that, first, gains are captured by rent, and second, the expansion becomes misdirected into real estate speculation. These effects are not caused by economic freedom, because a truly free market does not include subsidies. The greatest subsidy in economies today is the implicit governmental subsidy to land values.
Governmental public works and services make locations more productive and attractive, which increases the demand to be located in those locations, and therefore increase the land rent and land value if the landowners do not pay for these benefits. The current taxes on income and sales fall mostly on wages and investment returns.
Land is lightly taxed, as the property tax falls to a great extent on the buildings, takes only a small portion of the land rent, and is deductible from income taxes. In the USA, real estate speculators can sell tax-free by swapping into other properties, and they get a depreciation tax deduction even though the improvements are not losing value. Owner-occupants get a large capital-gains tax exemption. Another big subsidy is artificially cheap credit, as the central bank pushes down interest rates. In the USA, housing is further subsidized by government mortgage guarantees as well as purchases of mortgages by the Federal Reserve, Fannie Mae, etc.
The problem with economic growth is not markets, but subsidies. The subsidies can be eliminated by shifting taxation to land values, letting interest rates be set by the market, eliminating mortgage guarantees, and ending the government’s buying of mortgages.
Land value taxation, and the elimination of other taxes, would result in a geyser of economic growth. Workers would benefit in several ways: 1) labor keeps its earnings; 2) the land rent that captures the gains from growth benefits everyone; 3) economic expansion is sustainable, as the elimination of subsidies prevents the boom-bust real-estate cycle.
Those who complain about trickle-down and seek to tax the rich, fail to examine the source of wealth. They fail to distinguish between wealth from labor and entrepreneurship, and wealth from rising land rent and land values.
There is no trickle-down economics. There is no theory claiming that economies trickle, and nobody advocates trickles. The explanation for economic woes is diversion: government has interfered with the river of growth with dams (taxes that reduce the flow) and canals (subsidies that divert the flow). Those who seek equity and prosperity should think it through to conclude that what is needed is to let the economic river flow without diversions.
(This article first appeared on progress.org)
