The Fallacy of Trickle-down Economics: Whom Does ‘Wealth Creation’ Benefit?

Wealth creation is a great national service.

Let us never see wealth creators with suspicion.

Only when wealth is created, wealth will be distributed.

Wealth creation is absolutely essential. Those who create wealth are India's wealth and we respect them: PM @narendramodi

— PMO India (@PMOIndia) August 15, 2019

Prime Minister Narendra Modi has extolled the role of “wealth creators” in the economy on multiple occasions including during his Independence Day speech in 2019, and while replying to the Motion of Thanks on the President’s address in the Lok Sabha’s budget session in 2021. 

The concept of wealth creation by the private sector being essential to wealth distribution to the public is fundamental to the trickle-down theory in economics, which argues that benefits for the wealthy will “trickle down” to everyone else. The underlying proposition is that incentivising corporates and the wealthy to boost business investment in the short term (through tax breaks, deregulation, subsidies, etc) will benefit society at large in the long term (by raising outputs, creating employment, increasing spending, etc). 

But does such a proposition hold true? In this reading list, we comb through the EPW archives to look deeper into the implications of trickle-down economics. Do benefits for the wealthy actually “trickle down” and reach the poorest in society or does wealth created continue to stay concentrated in the hands of a few?

Who is Benefited from Corporate Tax Reductions?

One of the commonly invoked elements of trickle-down economics is tax benefits for corporations and high net worth individuals (HNIs), who are expected to invest the money that they save from taxes in entrepreneurial activities, which are, in turn, expected to boost production and create jobs.

Yet, going by the experience of the tax reform measures in India since 2019, corporate tax reductions may not promote growth and investment. On the other hand, such reductions may decrease government revenues, thereby squeezing the fiscal space for development programmes and government spending. J Dennis Rajakumar and S L Shetty (2020) wrote:

The revenue forgone due to the corporate tax rate reduction has adversely impacted the government tax efforts, as reflected in the reduction in GTR [Gross Tax Revenue] as per the RE [Revised Estimates] for 2019–20. Consequently, social sector spending is likely to be compromised. 

Further, they observed:

In terms of the tax potential for the economy, the new tax reform fritters away the largest component of such potential in the immediate period when the economy is badly in need of higher public investment and expansion of consumption activities. No doubt, the vast reduction in the corporate tax rate is likely to create a dent in government finances in the foreseeable future and the burden of government revenue may shift to individual income taxpayers and indirect taxes like goods and services taxes (GST).

An EPW editorial analysing the taxation and disinvestment outlook of the Union Budget 2021–22 reached a similar conclusion:

The big giveaways to the corporates also mean that the government has to squeeze spending for the middle- and low-income groups. Thus, while overall government expenditure is set to rise marginally by 1% to ₹348.3 lakh crore in 2021–22 and capital spending by 26.2% to ₹5.5 lakh crore, the revenue expenditure is set to fall by ₹82,142 crore or -2.7% affecting almost two dozen major government schemes whose allocations have been cut. This would include the nutritional social assistance programme, school midday meal programme, price stabilisation fund scheme, LPG (liquefied petroleum gas) direct benefit transfer, jobs and skill development scheme, Pradhan Mantri Awas Yojana and also schemes which particularly affect farmers like interest subsidy on short-term credit, fertiliser subsidy, procurement of foodgrains and assistance to sugar mills.

Besides reduced government spending and its concomitant effects, the key assumption behind tax reductions—that companies would be able to pass on such benefits to the public—can itself be questioned. Referring to the changes in the taxation policy brought about by the government in September 2019, Rajakumar and Shetty (2020) noted:

… whether these companies that stand to gain from the reduced corporate tax rate would transfer the benefits to customers is a moot question. Most of the large companies’ ownership is skewed in favour of a handful of promoters, whose marginal propensity to consume mass goods is recognisably very low. Thus, the latest corporate taxation policy of the government is not only based on misplaced priorities but also unduly regressive and designed to benefit a handful of companies. 

Reflecting on Rajakumar and Shetty’s paper in a letter to EPW, Nayakara Veeresha (2020) emphasised:

With the help of time-series data, the authors find that the “vast reduction in corporate taxes does not possess the potential to produce the desired outcome in so far as reviving corporate investment is concerned.”

Veeresha added:

The “heroic tax reform measures” cost heavily on the distributive justice aspects, especially in containing the increasing income inequality in society. The fiscal unsustainability of the reduction of corporate tax exerts financial burden on household income. 

Has Greater “Development” Led to More Inequality?

Be it tax cuts or other government incentives, the method that trickle-down economics adopts is that of boosting overall growth in the economy, in the hopes that the benefits of the development would be shared by all, including the most disadvantaged sections of society. But adding more to the wealth pie has no bearing on how the pie is distributed. 

This is demonstrated by the fact that wealth and income inequalities have continued to widen despite an increase in headline growth and gross domestic product (GDP) in the global and Indian economy. Ritwik Banerjee and Prerana Maheshwari (2020) highlighted:

India transitioned from a period of slow gross domestic product (GDP) growth of 3.5% in the early decades since independence to one of the fastest growing countries of the world in the 2000s. After the start of the liberalisation of the economy in 1991, the pace of growth picked up to 6.4% in the next two decades and possibly doubled the average productivity and living standards in just 16 years. However, the headline GDP growth number may actually hide the heterogeneity in growth rates of different income groups of the population.
… Income and consumption share data for the 20-year period 1991–2011 shows that there exists a large difference in the growth rates for various deciles of the income distribution. These differences have led to sharp increases in income and consumption inequality, a finding which is consistent with earlier studies. (Mazumdar et al 2017; Basole and Basu 2015; Anand and Thampi 2016) 

The statistics for wealth inequality are also similar. EPW Engage (2019) wrote:

In January 2018, at the World Economic Forum at Davos, an Oxfam report on global inequality reiterated, once again, that the rich are getting richer and the poor are getting poorer. According to the report, India’s wealthiest 10% now hold 77.4% of the total national wealth and the top 1% hold 51.53% of it. 

While poverty may have reduced in absolute terms and standards of living may have improved for a section of the poor, the widening inequalities—both among individuals and between identity groups—are a matter of concern. Thomas E Weisskopf (2011) analysed:

If economic growth were increased and poverty were reduced without a concomitant reduction in inequality, then the overall gains would be far less substantial than if inequality were simultaneously reduced.

In any case, poverty reduction has not kept pace with overall growth in the economy in India in the post-reform period. C H Hanumantha Rao (2009) highlighted:

Why has the pace of poverty reduction slowed down in the post-reform period despite the rise in per capita GDP at a faster rate? The rich-poor divide subsumes the “social divide”. The population belonging to socially and economically disadvantaged sections like scheduled castes, scheduled tribes and backward classes, and women and children have benefited the least from growth and rising prosperity. The slow improvement in the various development indices for these sections and the slow rise in public expenditure targeted at them as well as for social sectors like health, education and poverty alleviation programmes, and greater vulnerability of the poor to various kinds of risks in this period have been documented extensively in the literature. (Radhakrishna and Ray 2005; Dev 2008)

Going by Rao’s assessment, the trickle-down approach of taxation and other financial incentives for the wealthy would further constrain the fiscal space for the government to implement social sector programmes that benefit the disadvantaged sections. 

In fact, reducing economic inequalities is often believed to require measures that run completely counter to the premise of trickle down. Weisskopf (2011) argued: 

There is much that the government of a poor country such as India can do to reduce economic inequalities while promoting economic growth and combating poverty. The most promising policies that limit the economic gains of the rich are those that tax their income and (especially) wealth progressively, that reduce “corporate welfare”, that break up monopolistic market positions, and that shift ownership away from absentee asset-owners (especially of land). The most promising policies that expand the economic gains of the poor and the marginalised are those that improve their health, that increase their access to good-quality education institutions, that improve their access to credit markets, that promote higher employment, and that shift asset ownership to actual producers (especially cultivators). 

Can the Capitalist Model of Development Be Free from Inequality?

Are inequality and poverty the necessary corollary of the trickle-down economic model and neo-liberal policies? Or can income and wealth divides be bridged within a capitalist system?

Arguing that there may be something lacking in the theoretical framework underlying neo-liberal policies, Indira Hirway (2012) wrote:

“Inclusive growth” is a fashionable term these days, used widely in development literature. The term is used in a large number of emerging and developing countries at present in the context of the neo-liberal policy framework, which is expected to deliver growth – inclusive growth. Empirical evidence from most of these countries, however, indicates that the neo-liberal policies have not been successful in including the excluded in the mainstream development process. (Sen and Dreze 2011; Shukla 2010; Palanivel 2011; Chhibber 2011)

Likewise, an EPW editorial (2017) emphasised that extreme inequality was not an uncommon feature in the history of capitalism:

… the richest 1% that sets itself apart from the rest has been part of “the normal” in the history of capitalism, apart from the exceptional period from 1914 to 1975, marked by two world wars, the Russian and the Chinese revolutions, the Great Depression, and the welfare state in the post-World War II period up to 1975.

It added that the extraordinary increase in inequality has been accompanied by significant un­employment and underemployment, and considerable capacity underutilisation.

Hirway (2012) also added:

Though inclusion under this policy framework is expected to be achieved through trickle down effects of growth in terms of massive generation of productive employment, it appears that this framework has severe limitations with regards to ensuring (near) full employment of the labour force.

She explained the fundamental flaw with relying on neo-liberal policies to bridge the economic divide:

The main burden of including the excluded under this model therefore falls on redistribution of the revenues earned through higher rate of growth of the GDP. However, there are some basic problems with this approach. First, this approach does not change the ongoing process of growth that is responsible for exclusion of some sections of the population and some regions of the economy. As a result, the process of exclusion will continue in the economy, making redistribution efforts increasingly weaker. When inclusion is not embedded in the growth process, redistribution of its fruits is not likely to have any lasting impact on inclusion (Panagariya 2011). Second, redistribution is a political economy question. The strong vested interests developed during the first phase of growth under the neo-liberal policies may not permit the required level of redistribution. 

Vasundhara Jairath (2021) analysed how a strong political consensus has been built up around the historical interpretation of development that draws on the popular, even though sufficiently debunked, “trickle-down” theory of neoclassical economics. She wrote:

The neo-liberal state draws a natural and already assumed relationship between business ventures and the project of “development,” a project that continues to wield significant moral force in a developing country as India. 
 
… In a deceptive move, what are only the requirements of capital—labour, infrastructure and generation of profit—are sold to us as indices of “development.” 

She added:

The idea of development is moulded ever more closely to serving the needs of capital, rendering it void of any commitment towards the needs of the most impoverished sections of society. 

Rajan Gurukkal (2018) also put forth a similar argument regarding the term “development:” 

… in popular parlance the term “development” is taken to mean all that people aspire for themselves. Its usage cleverly and successfully conceals its real meaning: capitalist growth with underlying implications of “colonialism” and “imperialism.” 
… Despite the recurrence of recessions, capitalism expanded through fresh strategies of accumulation, which were able to acquire social legitimacy under the ideological veil of “development.” Development is, therefore, a mischievous term, but one of universal acclaim for something ideal. 

Even with the growing acknowledgement of inequalities in the development discourse, output-based development metrics such as GDP remain popular. Alternative approaches such as the Human Development Index have not been able to replace the trickle-down narrative. Balakrushna Padhi and Udaya S Mishra (2021) wrote:

There is an agreement that human deve­lopment is perhaps a necessary reflection of translating development to welfare, however, this still underlies the importance of means against the ends. Such an argument is made in the context of distribution vis-à-vis development wherein a fair distribution is considered ideal but a better magnitude of “means” is considered a prerequisite. In other words, there has to be an emphasis on making the cake bigger and bigger by any means and automatically the share of the cake in distribution will be larger and larger. This assumption of the obvious implication of means ­towards the ends is hypothetical and it all depends on how and in what manner is the means made or accumulated.

Their commentary rejects the assumption that income and production growth are an economic precondition without which inequalities cannot be addressed.

Read More

Present Crises of Capitalism and Its Reforms | Pulin B Nayak, 2020

Corporation Tax Cut: Who Bears the Burden? | EPW Editorial, 2019

From Trickle Down to Leapfrog: How to Go Beyond the Green Revolution? | Frédéric Landy, 2013

Patterns of Wealth Disparities in India during the Liberalisation Era | Arjun Jayadev, Sripad Motiram and Vamsi Vakulabharanam, 2007

Poverty and Inequality in China and India: Elusive Link with Globalisation | Pranab Bardhan, 2007

Poverty and Capitalism | Barbara Harriss-White, 2006