Study finds that 50 years of tax cuts for the wealthy did not trickle down

King's College London's Dr. David Hope and Dr. Julian Limberg, each holding a doctorate in political science, released a research study last week. They found that trickle-down theory did not work as expected.

The two British scholars conducted their research through the lenses of sophisticated statistical methodology. Their statistical approach first used Bayesian latent variable analyses to develop a measure of major tax cuts in 18 countries belonging to the Organisation for Economic Cooperation and Development, including Japan and the US, over 50 years (1965 - 2015). A latent variable is not directly observed but rather mathematically inferred from the other variables which are directly observed and measured. The latent variable in their data was found using a combination of the Monte Carlo simulation, which is used to estimate possible outcomes of an uncertain event, and the Markov Chain method, which establishes the probability of transitioning from one state to another.

Next, they sought to identify how tax cuts affect income inequality. Recognising that a simple statistical regression would not work, they instead used a non-parametric generalisation of the difference-in-differences indicator for panel data analysis. A non-parametric test is used when one knows that the population data does not have a normal distribution (a neat bell curve) and does not assume anything about the underlying distribution. Difference-in-differences is a statistical technique that looks at the average outcome difference between the control group and a group where treatment was applied. In this context, it would involve surveying the average difference in inequality over time in a country that implemented tax cuts for their rich and a country that did not. Then, the difference between the two differences would be analysed. They also used the Mahalanobis distance method, which measures the number of standard deviations an observation is from the mean of a distribution, to compare countries where tax was and wasn't cut.

Trickle down-theory may be regarded as a subset or an application of supply-side economics. While supply-side economic policies favour lowering taxes overall, trickle-down theory distinctively earmarks lowering taxes on the upper end of the economic spectrum. Trickle-down theory states that cutting taxes on the rich would encourage them to invest and work more, thus creating more jobs and benefiting everyone on the economic spectrum. However, the aforementioned study found that such directives only benefited individuals who were directly affected while increasing income inequality and having no effect on unemployment or growth in the short and long term. Dr. Hope and Dr. Limberg concluded that only top income shares increase, with little effect on economic performance, by cutting taxes for the wealthy.

Dr. Hope and Dr. Limberg's findings pose a significant counterpoint to arguments especially made in the US, which reason that policies that appear to inordinately aid wealthier individuals eventually trickle down and feeds the rest of the economy. Policies that aimed to do this were especially prominent during the Ronald Reagan era. Termed as Reaganomics, these policies did have notable dissenters, including George W.H. Bush, who described then-President Reagan's policies as 'voodoo economics' before ironically becoming his Vice President. While the study's research extends up to 2015, Dr. Hope noted that this analysis would also apply to President Donald Trump's 2017 tax cuts.

Based on the study, reasoning could follow that governments should not worry that the economy would be harmed by raising taxes on the wealthy to fund COVID-19 related financial costs. With taxes having been a subject of scrutiny during the pandemic, this study offers some relief to policymakers. The study could justify increasing capital gains taxes, which has a higher impact on individuals belonging to a higher salary bracket, in an effort to repair COVID-19 affected public finances.

This sentiment is already being seen across the globe, with Argentina sanctioning a one-off 'millionaire tax' and analysts in the UK calling for a similar one-off wealth tax. In July, earlier this year, 83 millionaires, under the banner 'Millionaires for Humanity,' also signed a letter requesting the super-rich to be taxed at higher rates. Jerry Greenfield, co-founder of Ben & Jerry's, and Disney heiress Abigail Disney were amongst these 83 individuals. The taxes collected would go towards helping pay for the respective country's pandemic response strategy. Overall, the pandemic could be seen as a solid reason as to why investing in public goods and services would do far more good than cutting taxes for the 1%. However, this school of thinking seems to be at odds with President Donald Trump, who only earlier this year doubled down on his plea to Congress to restore full tax benefits prized by business and lobbyists for fine dining and schmoozing.

The alternative to trickle-down theory is what is known as build-up economics. As per this model, the wealthy should pay for both the pandemic today and invest in the public's long term well-being. This model holds that everyone, including the rich, would benefit from this. It will be interesting to see how President-Elect Joe Biden's tax policies play out as he has rejected a wealth tax.