What is Trickle Down Theory?

Trickle down theory suggests that a policy of tax cuts and other financial benefits to businesses and rich individuals will indirectly benefit the broader and poor population.

How Trickle Down Theory Works

The basic principle of trickle down theory is that if top income earners have more money, they will invest their money in businesses that will produce goods at lower prices and employ more people. The principle tenet of the theory is that economic growth flows from the top to the bottom.

The basic policies promoted by trickle down theory have been reductions in the corporate net income taxes, lowering of the top individual tax brackets, and reductions (and eventual elimination) of the capital gains taxes.

The debate over the basic theory has taken many forms and been called other names, such as supply side economics (in the 1980s) and the horse and sparrow theory (in the 1890s). In the 1930s during the Depression, it became known as the 'trickle down theory.'

Why Trickle Down Theory Matters

Trickle down theory is heavily debated among economists and politicians. However, there is little empirical evidence that proves that it works. Periods of growth and decline are not highly correlated to changes in tax rates for the wealthy. Rather, these periods correspond to disruptive technologies, market growth, changes in variable business costs (e.g. oil and labor), and general business cycles.

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Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.

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