World Politics News   Articles for World Politics Course

David Hope and Julian Limberg of King’s College in London have published an article entitled “The economic consequences of major tax cuts for the rich” in the journal Socio-Economic Review. The authors take data from 1965 to 2015 from a number of countries in the Organization for Economic Cooperation and Development (OECD) which is a group of mostly rich countries in the world. The article tests the proposition commonly made that tax cuts on the rich benefit everyone by boosting economic activity–the “trickle-down” theory of economic growth. Surprisingly, there are few rigorous analyses of this basic contention which permeates discussions about tax policy.

The authors find that the proposition is not empirically justified:

“Our results show that major tax cuts for the rich increase income inequality in the years following the reform…⁠. The magnitude of the effect is sizeable; on average, each major reform leads to a rise in top 1% share of pre-tax national income of over 0.7 percentage points. The results also show that economic performance, as measured by real Gross Domestic Product (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, and this finding holds in both the short and medium run.

The time period is important because it reflects a substantial reduction in taxes on the wealthy: “Highly progressive income taxes arose in the wake of the two World Wars, with average top marginal income tax rates still standing at around 60% in the early 1980s. That decade proved to be a major turning point, however, and average rates have since fallen to under 40% (Scheve and Stasavage, 2016; Kiser and Karceski, 2017). This trend was mirrored in other taxes on the wealthy and corporations, which also dropped sharply over the past half century (Hope and Limberg, 2021).”

The conclusion of the article is direct:

“In sum, this study finds that major tax cuts for the rich push up income inequality, but do not boost economic performance. It therefore provides strong evidence against the influential political–economic idea that tax cuts for the rich ‘trickle down’ to benefit the wider economy. The study also points to a number potentially fruitful avenues for future research. It remains puzzling why ‘trickle down’ ideas have been so powerful and persistent in tax policy-making in the advanced democracies despite the lack of macroeconomic benefits from cutting taxes on the rich. “

What is most interesting about this finding is that we really did not need a rigorous analysis to dispute the proposition that lower taxes on the rich would lead to greater economic growth: “Whereas global GDP per capita grew by a yearly average of almost 2.8 percent during the 1960s and 1970s, growth from the 1980s to present has virtually halved, resting at just over 1.4 percent per annum.” But perhaps the most damning aspect of the “trickle-down” theory is that it is used as a cover for higher compensation for the CEOs of large corporations: “compensation for CEOs is now 278 times greater than for ordinary workers. That’s a stratospherically larger income gap than the 20-to-1 ratio in 1965.” The more accurate way to describe the economic theories of the last fifty years is “trickle-up”, not “trickle-down”.