Reaganomics, Trickle-Down Theory, Supply-Side Economics, or by any other name, is still a Fallacy

Trickle-down economics is actually a political term that has been referred to in various capacities as, “Trickle-down theory”, “supply-side economics”, or my personal favorite, “Reaganomics.”  This ideal is based on the premise that when the wealthy get to keep more of their money in the form of paying less taxes, that incremental income will “trickle” down the economic ladder in the form of increased payrolls and pay rates, as well as increased consumption of goods.  This assumes that the incremental income will be invested in business infrastructure and equity markets, thereby decreasing the cost of goods while increasing jobs and wages.

There are many reasons this premise is flawed, and I shall be over-joyed to share them with you.

• There are many investment options for the wealthy, as they are minimally constrained with what they can purchase.  Typically, investment into business infrastructure no longer comes in the form of a larger payroll.  Instead, companies are decreasing their payrolls via outsourcing, layoffs of higher-earning employees subsequently replaced by younger, cheaper employees, streamlining processes, and implementing technological solutions.  This is smart business because it increases the companies earnings, leading to an increasing stock price.  Most executives are the “wealthy” being discussed, and executive compensation is mostly comprised of equity (stock) compensation, with a typically much smaller percentage of income from actual salary.  Increase earnings, stock price goes up, rich get richer without any money trickling down; rather, they actually achieved this through taking jobs aways from those in the lower economic brackets.

• Production of goods, and thus the price of goods, is determined by supply.  If 1% of the population has more money to spend on consumables but the other 99% have less (or even the same) amount of money, the demand is actually decreased (or not sufficiently increased) and certainly not prompting higher production (which is the basis for the increased job portion of Reaganomics), and therefore prices don’t budge.  There is also the issue of product mix.  The wealthy are not purchasing all of the same goods as the rest of the country.  They are typically the ones who purchase the imported goods as imports are more often than not the “luxury” items.  Those consumables went straight to another country.  Not that stuff from Wal-Mart doesn’t eventually get traced back to China or Malaysia somehow, but at least the American retailers get most of the profit first.

• As you go up the scale in wealth, there is a corresponding increase in the craftiness of the people handling said wealth.  What I mean is that usually extremely wealthy people pay very intelligent and creative business people large sums of money to be good stewards of their fortunes.  These financial experts also have to compete with one another to obtain the patronage of wealthy clients, especially since they are so few in number.  The results of this competition are things like groups of mortgages with a certain guaranteed return (interest rate for the borrower…) being sold by banks to investment groups.  These investment groups are financed by money from the wealthy as an alternative to things like stocks and bonds.  So, in this instance, the higher the interest rate on the mortgages, the higher the return for the investment group, the higher the return for the wealthy.  Another example of how the rich get richer off of the lower economic classes.

• This is a bipartisan theory, no matter what anyone tells you.  Bill Clinton and George W. Bush both extended and increased the reforms put in place by Reagan’s administration.  This includes the 15% capital gains tax, the lowest in U.S. history, which strictly benefits those with enough income to invest in financial markets.  Proponents would argue that this makes sense based on trickle-down  principles and is clearly the proper course of action.  I think that the first bullet shows exactly why this is false.  The lower capital gains tax makes it more appealing for the wealthy to obtain more of their income through stock and the like.  It is not a coincidence that executives’ compensation is mostly derived from stock, it is because they know that they pay about half of the amount of income tax on capital gains as opposed to their salaries.  The top 1% earners of the country are all heavily invested in the stock market, no matter where their fortune was built.

• In addition to lower capital gains taxes, the Reaganomics reforms also lowered taxes on corporations.  This is in perfect line with the logic that the more money the company gets to hold onto, the more jobs, goods, etc.  Again from the first bullet: business infrastructure is undergoing a metamorphosis.   Corporate investments are being made overseas and in personnel-reducing areas.  They are not taking these increased profits and hiring more people.  They are paying higher dividends to their shareholders, who as we have demonstrated earlier, are mostly the wealthy.

• In order to offset the lowering of the two types of taxes above, the Reaganomics solution in the Tax Reform Act of 1986 was not to reduce spending (this would be too Republican, I mean, ACTUALLY a smaller government? Pretty please?), but to increase individual income taxes on the lower earners by decreasing the top tax tier from 50% to 28% and increasing the bottom tier from 11% to 15%.  In actuality, these became the only two tax brackets.  This restructuring of income-level brackets left a segment of the population which was previously classified in the 11% bracket now a part of the 28% bracket to bear a 154.5% increase in their income tax expense.  If they were previously in the 11% bracket, that means they were in the bottom portion of income earners.  The situation is such that people who were not making a lot of money to begin with are now having about 3/4 of what they used to before the tax reform.  This is where the government made out big on economies of scale.

• Don’t go giving me the Home Mortgage Interest Deduction argument.  This benefits a large number of non-wealthy Americans, so it would seem to be a more equitable piece of the Act?  Not so, because the people that just had their tax rate increased from 11% to 15% or even 28% do not necessarily have the requisite liquid cash to obtain a mortgage.  So they rent, and the landlord who owns the property may benefit from the deduction, but not the renter.  I would venture to guess the landlord is the one in the better financial situation of the two.  The Low-Income Housing Tax Credit was added for some semblance of balance in the Act.  This has been an effective tool for low-income households, but those who worship to the bust of Ronald Reagan condemn the people who are benefiting from the one thing he did to help the less economically fortunate.

To be honest, the list goes on and on.  There will be more to come including episodes on how Reaganomics resulted in the recession from the early 1990′s, the tech stock fiasco, and the current mortgage and home price situation.

Image Used in the Post

Ronald Reagan and John McCain image courtesy of flickr user pingnews.com published under the CC license. This picture provides some foreshadowing about what economic policies McCain probably has to offer.  Forget it, Obama won’t change this either.