It's a crock: Robert Frank on trickle-down economic theory

Check out this new Robert Frank column up at the NY Times about trickle down economic theory (you know the one, based on Ayn Rand's keen insight, that rich people, if they have to pay taxes, will stop working, so they deserve tax breaks at the expense of everyone else and the money they keep will "trickle down"). He takes it to task over the idea that it stimulates growth:

The surface plausibility of trickle-down theory owes much to the fact that it appears to follow from the time-honored belief that people respond to incentives. Because higher taxes on top earners reduce the reward for effort, it seems reasonable that they would induce people to work less, as trickle-down theorists claim. As every economics textbook makes clear, however, a decline in after-tax wages also exerts a second, opposing effect. By making people feel poorer, it provides them with an incentive to recoup their income loss by working harder than before. Economic theory says nothing about which of these offsetting effects may dominate.

Since, theoretically, anything can be proven in theory, it shouldn't be surprising that there are two theoretical justifications for seeing opposing effects from the same action. And people can be complicated that way.

So we instead look to historical data:

Trickle-down theory also predicts a positive correlation between inequality and economic growth, the idea being that income disparities strengthen motivation to get ahead. Yet when researchers track the data within individual countries over time, they find a negative correlation. In the decades immediately after World War II, for example, income inequality was low by historical standards, yet growth rates in most industrial countries were extremely high. In contrast, growth rates have been only about half as large in the years since 1973, a period in which inequality has been steadily rising.

The same pattern has been observed in cross-national data. For example, using data from the World Bank and the Organization for Economic Co-operation and Development for a sample of 65 industrial nations, the economists Alberto Alesina and Dani Rodrick found lower growth rates in countries where higher shares of national income went to the top 5 percent and the top 20 percent of earners. In contrast, larger shares for poor and middle-income groups were associated with higher growth rates. Again and again, the observed pattern is the opposite of the one predicted by trickle-down theory.

The whole thing is definitely worth a read.