How Giving the Rich Everything Hurts the Economy

Source: iStock

Source: iStock

Inequality is at an all-time high, ideological lines are being drawn in legislators all across the country, and Americans are wondering whether or not giant trade deals are going to help their chances at a prosperous life. It’s a whirlwind of uncertainty, and the economy is still sputtering six years after the financial crisis, despite signs that things have returned to normal.

The now long-standing question for legislators has been this: what can we do to quell growing restlessness among the lower and middle classes, and address the widening wealth gap? Some leaders thought they had the answers, like Sam Brownback in Kansas, or Scott Walker in Wisconsin, although their economic strategies have done more harm than good. The International Monetary Fund (IMF) has stepped up to address those strategies in a rather forthright way, declaring in a recent report that supply-side economics, or the ‘trickle-down’ model, is bunk.

The report, put together by five IMF economists, says that if governments truly want to spur economic growth and focus on building more prosperity, investment must focus on lifting the bottom 20% of earners — rather than coddling the highest earners, which ‘trickle-down’ theorists claim leads to shared prosperity given enough time.

“Widening income inequality is the defining challenge of our time. In advanced economies, the gap between the rich and poor is at its highest level in decades,” the report reads.

“Building on earlier IMF work which has shown that income inequality matters for growth, we show that the income distribution itself matters for growth as well. In particular, our findings suggest that raising the income share of the poor and ensuring that there is no hollowing-out of the middle class is good for growth through a number of interrelated economic, social, and political channels.”

Through varied policy approaches, the IMF does outline several ways in which legislators and political leaders can help foster stronger and more prosperous lower classes. The report itself takes data from economies of varied advancement, and found that many of the policies we’re seeing implemented by the world’s leaders today are only serving the top strata of earners.

Specifically, regressive tax policies, trends toward globalization, and the systematic and strategic weakening of labor unions and workers groups are all harming those on the lower-end of the economic spectrum. While there’s no panacea that the IMF has to offer, more progressive tax structures, as well as spikes to investment in public health and education, were the most important elements.

The juiciest nugget the IMF economists put forward is that by helping out the lowest 20% of earners, nations will see the most return in terms of economic growth.

“If the income share of the top 20 percent (the rich) increases, then GDP growth actually declines over the medium term, suggesting that the benefits do not trickle down. In contrast, an increase in the income share of the bottom 20 percent (the poor) is associated with higher GDP growth. The poor and the middle class matter the most for growth via a number of interrelated economic, social, and political channels. ”

While the IMF’s suggestions may ruffle some feathers, these revelations surrounding the ‘trickle-down’ theory are not new. In fact, supply-side theories are not taken very seriously by most mainstream economists (if it ever was), and as we’ve seen play out numerous times, the idea just doesn’t work in practice.

Right now, Kansas is the most obvious example of the theory’s failure.

What basically happens when supply-side policies are put into place is that the wealthy, already having enough to cover their basic needs, tend to save or invest the income boost they receive in the form of tax breaks. On the other hand, if the poor end up with more money on their hands, they spend it. That infuses money back into businesses as people buy groceries, or cars, or anything else, creating more demand and the need for jobs. Spending is the key to giving the economy a kick, and the rich have less incentive to spend than the poor do, in most cases.

Again, economists, by and large, already know this. The problem is that we continue to see these ideas put into practice, at the cost of economic health. This IMF report sends another warning shot up in the air, but whether policymakers take heed is another question entirely.

Follow Sam on Twitter @SliceOfGinger

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