Here's a crazy idea: let's give tax cuts for wealthy people and companies and that will benefit the poor. According to a recent study, this approach (recently advocated by the Trump administration, among others) is just that: a crazy idea that doesn't work -- all it does is increase inequality.
In 2017, President Trump sold his tax cuts as "rocket fuel" for the economy. The idea is that tax cuts on the wealthy would free up money that would allow companies to hire more people, ultimately helping those in need. Trump is far from the only one to propose this approach. Several leading US politicians (typically on the Republican side) have advocated measures along this line.
It seems counterintuitive, but economics isn't always intuitive. It seemed to work during the Reagan years, and the supporters of trickle down economics (initially used as a pejorative term) saw it as a win. Like a pyramid of champagne glasses, they said, you just need to fill the top glass, and then it will flow naturally to the others. But the top glasses have been getting bigger and bigger, and next to nothing is flowing to the glasses below.
Simply put, economic inequality is steadily on the rise in the US. The poorer 80% of the country only own 7% of its wealth. Productivity has increased constantly for US workers and for a time, the median income increased with it -- but after the measures in the late 80s, things changed.
In the late 1980s, multiple countries implemented tax cuts for the well-off. The latest study analyzed data from 18 developed countries, including the US, looking at the connection between trickle-down tax cuts and economic growth. Their conclusions leave little to interpretation:
"The results also show that economic performance, as measured by real GDP per capita and the unemployment rate, is not significantly affected by major tax cuts for the rich. The estimated effects for these variables are statistically indistinguishable from zero," the study reads.
This is far from the first study to come to these conclusions. A 2017 working paper found that the effects of tax cuts are "heterogeneous" -- tax cuts on the poor do help the poor. Tax cuts on the rich do little for the poor. A 2015 analysis from the International Monetary Fund also concluded that the benefits don't really trickle down, and a recent analysis also found the same thing.
The recent study shows that trickle down tax cuts aren't just useless, they can be harmful. Economic inequality isn't just a moral problem -- it's a practical one. A number of studies have highlighted the negative effects of inequality, from higher crime and lower social cohesion to health problems and political instability.
So where does this leave us? Tax cuts on the rich, believe it or not, benefit the rich -- not the rest. In theory, trickle down economics works; in practice, it doesn't. David Hope, one of the study authors and Visiting Fellow at the London School of Economics sums it up:
“Our research shows that the economic case for keeping taxes on the rich low is weak. Major tax cuts for the rich since the 1980s have increased income inequality, with all the problems that brings, without any offsetting gains in economic performance.”
For governments looking to genuinely improve the economy, this should be very helpful: it shows what doesn't work, and suggests what does. Julian Limberg, the other study author, comments:
“Our results might be welcome news for governments as they seek to repair the public finances after the COVID-19 crisis, as they imply that they should not be unduly concerned about the economic consequences of higher taxes on the rich.”