“Trickle Down” Economics Are Well-Established Fact

There’s nothing more that progressives love more than snickering at “trickle down” economics.  They believe that trickle down economics are some sort of supply-side nonsense which has been thoroughly discredited by history– in reality, so-called “trickle down” effects are a well-established feature of Keynesian economics– in fact, it is hard to find any mainstream economic model that does not explicitly include trickle down effects as a prominent feature, and virtually all economists will readily point out the problems with the “no trickle down” position, which more generally is a subset of the flypaper fallacy.

The premise of trickle-down economics is simple: in order to produce goods, businesses use a combination of low-skilled (and generally low paid) labor, high-skilled (high paid) labor, and capital.  Most economic models use what is called a “Cobb-Douglas” production function, which looks like Y = L^a * H^b * K^c where Y is output, L is low-skilled labor, H -s high-skilled labor, and K is capital (one can also toss in other factors of production, like land).

The payments that go to each factor of production depend upon their marginal product– that is, if you took a partial derivative with respect to the factor, the result would be equal to the market wage or rent.  If you do the math, it is clear that the productivity (and thus wages paid) of low-skilled labor depends to a considerable degree on the amount of capital and high-skilled labor it is paired with.

The idea of “trickle-down” economics is then spurred by a simple observation.  If a tax on high-income earners or capital reduces the amount of those resources supplied, then low-income workers will feel some of the burden.  In fact, given a high enough elasticity of supply, one can find that sometimes, more than 100% of the burden of a tax placed on one factor of production is borne by another factor of production– the classic analysis that produces this effect is when you take a two-sector economy and tax capital in the labor-intensive sector.

Capital is highly elastic, owing to the fact that it can easily be transferred to another country.  If the capital gains taxes in America are high, no problem– just invest your money overseas.  High-skilled labor is also elastic– not as much as capital, but still moreso than low-skilled labor.

And so, conservative proponents of tax cuts for the wealthy are not, as progressives like to pretend, purely interested in helping out the rich.  They’ve simply looked at the elasticities and discovered that if one lowered the tax rates on capital gains and upper-income brackets and raised them on the poor, the poor would actually be better off.  In the business of economics, we call this a Pareto improvement– both the poor and rich are made better off by the tax change

Admittedly, conservative elasticity estimates for income taxes are on the higher end of the spectrum (though for capital, they’re very likely right).  But regardless of the magnitude of the effect, it exists.  Taxes on the wealthy hurt the poor, sometimes even more than they hurt the wealthy.

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