Tuesday, March 3, 2009

What "Trickle-Up" Economics will look like

When President Obama released the summary of his first budget for fiscal year 2010 he stated that the past eight years had "once and for all" refuted the notion that the economy can grow by letting wealthier Americans keep more of their earnings, or as Thomas Jefferson called it, "the fruits of their labor."
Of course while Mr. Obama was running for president he repeatedly claimed that we need to grow the economy "from the bottom up" rather than from the top down.

His budget is a fulfillment of his campaign promise to go after those who run our businesses and supply us with the things we want and need by raising the top two income tax brackets while expanding income tax credits to millions of Americans who - hang on to your seats - currently pay no income taxes.
How, you might ask, can you cut taxes for people who pay zero taxes? It is simple. If you are a poorer American who has a job you qualify for what the government calls the Earned Income Tax Credit. After taking your legal tax deductions to bring your income tax obligation to zero you then get a check - from the earnings of other taxpayers - on top of that. In effect you receive a welfare payment for getting up and going off to serve your fellow man.

Under the Obama budget he will give even more people a tax credit which will, according to estimates, lead to almost 48% of all Americans owing no federal income taxes at all. 52% of us would shoulder the burden for the more than $3.5 trillion budget he has envisioned for our nation.

Under his "trickle up" economics theory, by creating even fewer taxpayers at the bottom rung of the income scale we will get more people buying the things businesses offer for sale. More buying means more demand. More demand means more jobs, in theory, for those who will be needed to supply low-wage earners with goods and services.

The next several years will be a lot of fun for economists who study the relationship between income tax rates and economic performance. The "theory" of trickle-down economics has been studied for decades. The data from the U.S. in the 1920s, 1960s, 1980s and 1990s, along with data from China, Eastern Europe, Chile, Sweden, Ireland and other parts of the world is quite clear. When tax rates fall - especially rates paid by the most productive members of the economy - the jobs and wealth created from the top all the way down to the bottom is significant. In effect, poor people become relatively wealthy poor people in places that reward risk takers.

We have not yet seen what happens under the "trickle-up" theory. However, if hammering richer people during a horrible recession while cutting taxes for people who work at McDonald's leads us to the prosperity Mr. Obama claims we will see, I will be the first to argue that Mr. Obama should win the Nobel Prize in Economics.

Stay tuned....


  1. Professor, low wage earners are still paying payroll taxes, and the majority of their income is spent on non-discretionary items. Also, the tax plan Obama is implementing isn't all that different in scope than Bill Clinton's, which is widely hailed as being successful; it was the engine of the surplus he created and allowed for paring back of the national deficit. In addition, Bush's tax cut wasn't opposed only because it was a "trickle down theory" but also because of the timing - during 2 wars. He effectively placated the nation with low interest rates and low taxes while he spent ridiculously and created the 1.75 trillion deficit we now have. Trickle down works in some respect, especially when rates are lowered on capital gains and dividends, but lowering income taxes does not always increase revenue. In fact many times it has not.

  2. I don't think that we got into this horrible recession because of high taxes. This began with the government mandating that every American live out the "American Dream" of owning a home wether or not they could afford it. Congress mandated Freddie and Fannie to supply loans to people with subprime credit, which then got sold in packages to investors. When people realized that they could not afford these houses because a progressive interest rate or could not sell because of oversupply in the market. They resulted in default and thus popped the balloon of rising home prices.

    The markets are frozen, meaning businesses and individuals do not have access to capital which limits their ability to business and take risks to pursue business. Banks will continue to sit on their cash until their liabilities are either reduced or taken off their balance sheets.

    The Fed should have stayed out of Wall Street and banks to begin with, the moment the Chairman Bernanke decided to step in created chaos in the market, which was soon followed by main street.

    What Mr. Obama should consider is cutting taxes on the middle class and reward individuals and corporations that take risks successfully, will enable the American economy to quickly recover on the road to prosperity.

  3. Shouldn't President Obama try to at least solve the housing crisis first before promising all these tax cut? Where is all this money coming from to build things to create new jobs, if he is promising tax cut? There's not enough people in the U.S. to give him the money he needs to fulfill all his promise. What do you feel about California filing for bankruptcy? They owe a huge amount of money of taxes. About 27 billion or so.

  4. I believe that punishing achievement, as Prof. Chambless so eloquently put it, "hammering richer people," is no way to grow the economy, much less get out of this recession.
    The so-called "rich" people will take their resources elsewhere where they would be rewarded. And I don't blame them. Wouldn't you do the same?
    In addition, this will lead to more tax evasion.
    The biggest problem I have with this "Trickle-Up" Economics is that it stifles ambition and entrepreneurship, and isn't that what really makes America what it is??

  5. Mr. Chambless,
    I enjoyed your new blog on liberty and overview on Obama. I am in total agreement of his unclear policies and how he plans to help us, not hurt us. Thanks for sending me this blog, I was a student of yours back in 2005.
    On another note, below is something that was sent to me at work I thought you might enjoy!
    Danielle Poz



    STATEMENT MADE BY THE LATE DR. ADRIAN ROGERS OF BELLEVUE BAPTIST CHURCH, MEMPHIS , TENNESSEE: You cannot legislate the poor into freedom by legislating the wealthy out of freedom. What one person receives without working for, another person must work for without receiving. The Government cannot give to anybody anything that the Government does not first take from somebody else. When half of the people get the idea that they do not have to work because the other half is going to take care of them, and when the other half gets the idea that it does no good to work because somebody else is going to get what they work for, that, my dear friend, is about the end of any nation. You cannot multiply wealth by dividing it.

    Response: By Jason Ciekot

    "Such a simple realization of why liberal policies don't work, yet no one gets it?! Well except for us.
    Here is an easy test: try this democratic approach of wealth distribution concept in schools. Take all the A's the hard working students get and tell them we have to take away two letter grades, give them C's, to help the lazy students. Give these F students D's or C's. Even if this system works perpetually as described, the class average DROPS. (lets consider this a measure of the "health" of an economy) But we all know that in reality, just as Mr. Rogers states, that the A students would wise up and realize they have no incentive to work for that A when it just gets taken away. They tell the teacher "up yours!" and just work hard enough to get a B or C. The F students continue to do nothing because they are getting letter grades for at everyone else's expense doing just that, nothing. Productivity goes down, and the "economy" collapses since there are no A's to support the F's anymore, society degrades and ultimately the classroom is destroyed and FAILS.
    Maybe we need to send our "leaders" back to school..."
    Jason Ciekot

  6. Mr. Wilson is right. The bush tax cuts were widely ineffective. But he also highlighted a central point that points to why they were: increased spending. We all know as individuals that if we expect a decrease in income we should alter our spending habits to compensate for that decrease. Mr bush, unfortunately could not or just did not grasp that concept.

    If we look back in the history of tax cuts as Mr Wilson suggests, we see that it does spur economic growth when properly applied. Ronald Reagan, the champion of not just the republican party but economic liberty, cut taxes from a staggering 14 brackets to 2. the top marginal rate was cut buy 42% to 28 percent. this however is only the beginning of smart trickle down economics. he followed this by deregulating the economy and thereby removing the extra costs of just doing business. thus encouraging more risk taking. he put a clamp on government spending by cutting the budget by 5%. this included a decline by ultimately 17% in non defense discretionary spending. The reason the Reagan cuts were so effective and the bush cuts weren't was because of the hampering of government spending. with the bush administration financing two wars and a bundle of entitlement programs and prescription drug legislation, its easy to see why his cuts didnt work.

    cutting taxes for not just the rich but all american is a good idea. It brings about economic growth and makes for a robust economy where people can take more risks. but on a moral basis it is just what is right. the federal government has little if any claim on the "fruits of our labor", that's just common sense. i fail to see how a giant entity separated by both distance and relationship can know how to spend my money better than i can. Its my money. I earned it. I should keep it.

    trickle down economics works. but just like any good idea it has to be applied properly to work.

  7. The government has been operating on short term policies and programs extensively since the Clinton administration. As soon as the economy was seen as taking a down turn they would print money, pass a stimulus package, lower taxes, raise or lower interest rates, or bailout airlines, car companies, and steel produces. Politicians have polluted our economy and artificially inflated it beyond all imagination.

    If the president announced that over the coming years we are going to cut spending and lower taxes on income, capital gains, and corporations; do you really believe that the stock market would be hovering around 6,500? Would unemployment be heading towards 10%? What do your instincts tell you?

  8. I will admit, I am in the low tax bracket that gets the welfare from other taxpayers, for now. While I think this system is not quite right, I will accept the extra money. I just hope I am able to get a job when I finish school. I know with the economy the way it is, I will likely stash my extra money in case my wife loses her current job and we cannot find one quickly enough after. I'm not so sure that extra money will help the economy much . . .

  9. Earned income tax credit, Isn't that issued only to working single parents... I still believe that a flat tax for EVERYONE would be the most balanced situation. Consumption will choose who pays more than others. But I ask this questions Professor, In times like these who the hell is spending that much anyway... would that lead to less money for the Govt to give away for idiots like AIG that lost another several hundred million dollars in their first quarter financial statement !!! That burns me the hardest WHY ARE THEY STILL GETTING MONEY FOR LOSING 400,000 a minute !!

  10. The merits of the stimulus package are severely undermined by the need to act fast. The truth is, Democrats are least interested in short-term relief for the "people" but mostly in advancing a progressive agenda that would otherwise be unpopular in America. Chief of Staff Rahm Emanuel articulated it clearly: "You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things you otherwise could not do before."
    I strongly believe that the stage is set for a Socialist Experiment in America that will inevitably lead to a "lost decade" while China & India gain ground on the US Economy.
    I am not sure how much more money can the US borrow to keep up with the rising future obligations. In many ways, we are running a ponzi scheme borrowing from foreigners based on a history of Economic strength we can no longer back up with factual performance.

    On an unrelated, please read this article by Gary Becker.

  11. Ladies and Gentlemen: The article above is nothing more than a comparative statement: "trickle-down" OR "trickle-up". Compare the empirical evidenced "trickle-down" economic outcomes against the "trickle-up" economic outcomes. While Mr. Chambless is correct when stating that a true "trickle-up" theory has yet been tested, there are similar enough scenarios to gauge probable outcomes. Trickle-down works, over significant periods of time. It is not perfect and is subject to correction, sometimes quite painful. Trickle-up does not sustain economic prosperity, much less expansion. Look no further than the dismal history and economic conditions of the former Soviet-bloc nations. True, that brand of communism does not run parallel to the current Obama plans; however, the notions that undergird the philosophy of both are very similar. Both REQUIRE strong central control or influence over matters us in the free world use to deem the sphere of free-markets. Both perpetuate a utopian desire for a classless society...uplift the poor while not (officially) allowing an upper-class. For trickle-up to occur, today, would require no less than wholesale societal re-engineering here in America.

  12. Mr Howard, "trickle-down" Economics do not promise a "utopian classless society". It promises a less painful income disparity that otherwise propagated by socialists (or as Prof. Chambless puts it, relatively wealthy poor people). To be completely honest, the "trickle-down" effect is a relatively irrelevant excuse made up by the market winners (mainly hard-workers, some cheaters) to diffuse the market losers (mainly the lazy). Nonetheless, the truth is the free market system does not promise equality of outcomes but equality of opportunities. Americans seem to have lost their grip on what THIS country was founded on; just as ex-socialist countries are finally coming around and betting their futures on our founders' morals and ideas. It's a shame that the same American "arrogance" & "optimism" is leading us to believe that we can succeed where France, India & China have failed: Socialism...

  13. Sami: Sorry for confusion. The word "Both" in "Both perpetuate a utopian desire for a classless society..." does not refer to trickle-up AND trickle-down: it refers to "both" the desires of Mr. Obama and central thoretical tenet of communism.

  14. Although, I read everybody's comments about "trickle-down" theory and how it is much better than "trickle-up" distribution of wealth model. I do believe that "trickle-down" is the best way to prosperity and long term growth but I pose the question, given that Wall street and main street are connected no matter what anybody says What probablity is there that if we were to cut taxes on wealthy that they would actually reinvest those leftover monies given that they see the market has droppped to it's lowest levels since 96. I mean think about it if somebody gave you a million dollars would you put your money in the market or invest in some other asset class as real estate, pe, vc, etc. All I know is that I would keep my money in cash or I would be short(meaning i think the market will go lower) because of the lack of confidence; and eventually that is what it all boils down to. Everybody and their mothers who directly or indirectly affects market conditions have no confidence whatsoever, and that is what it all boils down to.

  15. It is a big motivator to know that someday, I can go from the 15% tax bracket to the 39.6% bracket!

    Who wouldn't want to put in all that extra effort and risk to be able to hand nearly half over to help fund wasteful programs like the FDA and welfare!?

  16. @Matt:39.6% is a long way from 50.0% bud!

  17. @HondaPrelude: 10.4%. I wasn't clear about where that 50% was coming from. 39.6% from income.
    But I spend a lot of money. I am sure I could spend over $1000 in sales tax a year. I run a few websites under a business entity which is also taxed. I will have to pay property taxes and at some point this year I may be charged capital gains taxes. I smoke cigars from time to time. The new tobacco tax is taking around $1 for each cigar I smoke (+ sales tax). Plus all the money that is wasted for all the various tariffs and embargos (the reason why I have to pay double or triple price for a Cuban cigar).

    I meant that my tax burden total is half of my money. I apologize for not being clear.

  18. Nobody pays 39% of their income to the goverment. People are getting confused with their income tax bracket and how much $ they pay.

    Look at the Palins.

    Palin had a gross income of nearly $170,000 last year and paid nearly $25,000 in taxes.

    The campaign also says the couple made nearly $130,000 and paid about $12,000 in taxes in 2006.

    They are surely in a high bracket, yet they paid 9% and 14% the last two years. Its NOT nearly as oppresive as we make it sound when we quote "39% tax bracket".