Trickle-Down or Gush-Up? The Economic Science of Major Tax Cuts

The age-old debate over the most effective way to foster a thriving economy often boils down to a fundamental question: should economic stimulus be aimed at the top or the bottom of the economic pyramid? This question is at the heart of two competing economic philosophies: "trickle-down" and "gush-up" economics. The former, more formally known as supply-side economics, posits that by cutting taxes on the wealthy and corporations, the benefits will eventually "trickle down" to everyone in the form of jobs and higher wages. The latter, often referred to as "middle-out" or "bottom-up" economics, argues that the economy grows strongest when the purchasing power of the middle and lower classes is bolstered, causing prosperity to "gush up."

This article delves into the theoretical underpinnings, historical applications, and empirical evidence behind these two opposing views. We will explore the intellectual origins of trickle-down economics, its prominent applications in the United States and the United Kingdom, and the data-driven analyses of their effects. In parallel, we will examine the arguments for a demand-driven approach and the evidence supporting the idea that a strong middle class is the true engine of economic growth.

The Allure of the Downward Flow: Understanding Trickle-Down Economics

The term "trickle-down economics" is believed to have been popularized by humorist Will Rogers as a way to critique the economic policies of President Herbert Hoover during the Great Depression. Despite its often pejorative connotation, the core idea has been a mainstay of conservative economic thought for decades. Proponents generally prefer the term "supply-side economics," which they argue more accurately reflects their focus on stimulating the production of goods and services.

The central tenet of supply-side economics is that by reducing the tax burden on corporations and high-income earners, the government can incentivize investment, innovation, and expansion. This, in theory, leads to job creation and a more robust economy that benefits all strata of society. A key component of this theory is the idea of deregulation, which posits that removing government controls on industries spurs competition and efficiency.

The Laffer Curve: A Cornerstone of Supply-Side Theory

A foundational concept often cited by supply-siders is the Laffer Curve, developed by economist Arthur Laffer. The story of its creation has become something of a legend: in 1974, Laffer reportedly sketched the curve on a napkin during a restaurant meeting with politicians Dick Cheney and Donald Rumsfeld, and journalist Jude Wanniski.

The Laffer Curve illustrates the relationship between tax rates and tax revenue. It suggests that at a tax rate of 0%, the government collects no revenue, and at a tax rate of 100%, it also collects no revenue because there is no incentive for anyone to earn income. Between these two extremes lies an optimal tax rate that maximizes government revenue. The curve's crucial implication is that if tax rates are on the downward-sloping portion of the curve, a tax cut could actually lead to an increase in government revenue by stimulating so much economic activity.

Critics, however, argue that the Laffer Curve is overly simplistic and that its assumptions don't always hold true in the real world. They point out that there is no consensus on what the optimal tax rate is, and that the curve's predictive power is unreliable. Some also raise a more fundamental question: should maximizing government revenue be the primary goal of tax policy?

Historical Applications of Trickle-Down Policies

The most prominent and widely studied application of trickle-down economics occurred in the United States during the presidency of Ronald Reagan. "Reaganomics," as it came to be known, was built on four pillars: reducing government spending growth, lowering federal income and capital gains taxes, reducing government regulation, and tightening the money supply to curb inflation.

The Reagan administration implemented two major tax cuts: the Economic Recovery Tax Act of 1981 and the Tax Reform Act of 1986. The 1981 act significantly lowered the top marginal income tax rate from 70% to 50% and slashed the capital gains tax. The 1986 act further reduced the top rate to 28%, though it also raised the lowest tax rate.

Proponents of Reaganomics point to the economic recovery of the 1980s as evidence of its success. They highlight the creation of 20 million new jobs, a significant decrease in inflation from 13.5% in 1980 to 4.1% by 1988, and a rise in the net worth of families in the middle-income brackets. They argue that the tax cuts, combined with deregulation, unleashed the entrepreneurial spirit of the American people and led to a period of sustained economic growth.

However, critics of Reaganomics offer a different interpretation. They point to a tripling of the national debt during Reagan's time in office and a widening of the income gap between the rich and the poor. They also note that the 1981 tax cuts led to a 6% drop in real-term revenues, prompting a subsequent tax increase in 1982 to stabilize government finances.

Other notable examples of trickle-down policies include the tax cuts under President George W. Bush in the early 2000s and President Donald Trump in 2017. In the United Kingdom, the economic policies of Prime Minister Margaret Thatcher in the 1980s mirrored many of the principles of Reaganomics. More recently, a 2022 mini-budget by then-Prime Minister Liz Truss, which included significant tax cuts, was seen as an attempt to revive Thatcherite, trickle-down policies.

The Counter-Narrative: Gush-Up Economics and the Power of the Middle Class

In direct opposition to the supply-side approach is the theory of "gush-up" or "middle-out" economics. This perspective is rooted in the work of John Maynard Keynes, a British economist who rose to prominence during the Great Depression. Keynesian economics argues that the primary driver of economic growth is aggregate demand—the total spending on goods and services in an economy.

The central idea of gush-up economics is that to stimulate the economy, you should put more money into the hands of those who are most likely to spend it: the middle and lower classes. This increased spending creates a virtuous cycle of demand, leading businesses to hire more workers and produce more goods and services.

Keynesianism vs. Supply-Side: A Fundamental Divide

The difference between Keynesian and supply-side economics represents a fundamental disagreement about how economies function. Keynesians believe that in times of economic downturn, the government has a crucial role to play in stimulating demand through fiscal policy (government spending and taxation) and monetary policy (controlling the money supply and interest rates). Supply-siders, on the other hand, argue for less government intervention, believing that the free market, when unshackled by taxes and regulations, is the most efficient engine of growth.

A key argument from the gush-up perspective is that the wealthy have a lower marginal propensity to consume. In other words, for every extra dollar they receive, they are likely to save a larger portion of it than someone with a lower income. Therefore, tax cuts for the wealthy are less likely to translate into immediate consumer spending that drives economic activity.

Historical Precedent and Modern Proponents

While trickle-down policies have a clear lineage of conservative champions, the principles of gush-up economics have been influential in progressive and liberal policymaking. The New Deal policies of President Franklin D. Roosevelt, which responded to the Great Depression with large-scale public works projects and social safety nets, were heavily influenced by Keynesian thinking. The goal was to put people back to work and increase their purchasing power to revive the moribund economy.

In more recent times, proponents of gush-up economics advocate for policies such as raising the minimum wage, expanding the earned income tax credit, and making investments in education and infrastructure. They argue that these policies not only stimulate the economy but also lead to a more equitable distribution of wealth.

The Evidence: What Does the Data Say?

The debate between trickle-down and gush-up economics is not just a theoretical one. Economists have spent decades analyzing the real-world effects of major tax cuts and other fiscal policies. While the results are often complex and subject to interpretation, some clear patterns have emerged.

The Impact on Economic Growth

The core promise of trickle-down economics is that tax cuts for the wealthy will lead to higher overall economic growth. However, the evidence on this front is mixed at best. A 2019 study published in the Journal of Political Economy found that the positive relationship between tax cuts and employment growth is largely driven by tax cuts for lower-income groups. The study concluded that the effect of tax cuts for the top 10 percent on employment growth is small.

Furthermore, a landmark 2020 study by researchers at the London School of Economics and King's College London analyzed 50 years of tax cuts in 18 developed countries. The study found that major tax cuts for the rich have not led to significant increases in economic growth or employment. Instead, they have been associated with a rise in income inequality.

The Impact on Income Inequality

One of the most consistent findings in the economic literature is that trickle-down policies tend to exacerbate income inequality. The aforementioned study of 18 developed countries found that the share of national income held by the top 1% of earners increased in the years following major tax cuts for the wealthy. This aligns with the critiques of Reaganomics, which argue that the policies of the 1980s led to a widening of the gap between the rich and the poor.

Proponents of trickle-down economics sometimes argue that a certain level of inequality is a natural and even necessary byproduct of a dynamic, capitalist economy. They contend that the prospect of accumulating wealth incentivizes the risk-taking and innovation that drive progress. However, a growing body of economic research suggests that high levels of inequality can actually be a drag on economic growth by depressing consumer demand and limiting educational and economic opportunities for a large segment of the population.

The Impact on Government Revenue

The Laffer Curve's prediction that tax cuts can pay for themselves is a central pillar of the trickle-down argument. However, there is little empirical evidence to support this claim in the context of modern, developed economies. The 1981 Reagan tax cuts, for instance, were followed by a decrease in tax revenue, necessitating a subsequent tax increase.

More recently, the Tax Cuts and Jobs Act of 2017, signed into law by President Trump, was projected by the Congressional Budget Office to significantly increase the national debt over the following decade. While proponents argued that the tax cuts would spur enough economic growth to offset the revenue loss, this has not been borne out by the data.

Conclusion: A Complex Interplay of Factors

The debate between trickle-down and gush-up economics is likely to continue for the foreseeable future. The reality is that the impact of any major tax cut is incredibly complex and depends on a multitude of factors, including the state of the economy at the time, the specifics of the tax changes, and the accompanying monetary and fiscal policies.

The evidence suggests that the central promise of trickle-down economics—that tax cuts for the wealthy will lead to broad-based prosperity—has not been consistently fulfilled. While such policies can certainly benefit the wealthy, their positive effects on overall economic growth and employment appear to be limited. Moreover, they have been consistently linked to a rise in income inequality.

On the other hand, the arguments for gush-up economics—that a strong middle class is the engine of economic growth—are supported by a growing body of evidence. Policies that increase the purchasing power of the middle and lower classes appear to be more effective at stimulating demand and fostering a more equitable and robust economy.

Ultimately, the choice between these two approaches is not just an economic one; it is also a question of values. Do we prioritize a system that rewards the "job creators" in the hope that the benefits will trickle down, or do we believe that a more equitable distribution of wealth from the outset is the key to a more prosperous and stable society? As we continue to grapple with the economic challenges of the 21st century, this fundamental question will remain at the forefront of the political and economic debate.