The "trickle-down theory" has long been despised by liberals, derided by many economists, and scorned by politicians. But it has been grasped like a returned hostage by the Reagan administration.
This is the theory that making the rich richer will bring prosperity to the nation. By using economic policy to add to the incomes of the wealthy rather than the poor, the government will prompt more savings. The poor would just spend any extra funds on food, household goods, cars, or whatever. But the well-to-do can afford to save a larger proportion of their enlarged incomes. These extra savings will be invested in productive enterprises that provide better and more jobs for the poor. Thus income will "trickle down" from the wealthy to the poor.
But is the theory valid? Is it the only way to provide the investment funds needed by the nation for the revitalization of industry?
As with many economic issues, the answer is "yes" and "no."
On the "yes" side, noted Dr. Martin Feldstein, president of the National Bureau of Economic Research, is the fact that something like half the nation's households have zero or negative net assets outside of their homes and pension rights.These families have debts that match or exceed their assets.They are unlikely to receive any substantial interest or dividend payments.
Money invested in homes does not buy modern plant and equipment. Nor do social security rights, since this system is on a pay-as-you-go basis, with present workers supporting the retired. Social security payments are not paid out of some massive fund's income built up over the years by retirees during their working years.
Private pension funds, to the extent they are properly funded, do provide some investment money.
Another pro-trickle-down fact is that net private savings (including individual) savings and corporate retained earnings) amount to only about 5 percent of gross national product, the total output of goods and services in the country. That's a considerably smaller percentage than prevails in many other industrial nations.
"The basic facts are very sad," commented Dr. Feldstein, who was considered by the Reagan administration for a job as chairman of the President's Council of Economic Advisers.
Dr. Feldstein agrees heartily with the basic Reagan premise that the nation needs to save more to provide the means for increasing output and productivity. But he would modify the techniques for reaching that goal.
President Reagan's tax proposals of last week included personal income tax cuts of 30 percent, 10 percent per year for three years. That means a revenue loss in the first year of about $30 billion.
On the "no" side to "trickle down," Dr. Feldstein maintains it is not sufficiently encouraging to saving by the middle class. A typical individual in that income area might, after the continued impact of inflation, find his marginal tax rate drop from 30 percent to 25 percent. Or, reversing those figures, that person would be able to invest 75 cents instead of 70 cents of any saved dollar. That is not much of a change.
The Harvard University economist would instead devote perhaps $20 billion of the $30 billion in lost federal revenues to direct savings incentives which would reward the thrifty, whatever their income level.
For instance, tax-deferred individual retirement accounts are at present available only to those without recognized private pension plans. Dr. Feldstein would permit anyone to open an IRA and perhaps enlarge the amount that could be set aside tax free for investment until withdrawn at retirement. (That amount is $1,500 per year, or $1,750 for plans including a spouse.)
Further, Dr. Feldstein suggests enlarging the tax advantages of savings or stock investment. As of this year, a family can exclude up to $400 of interest and dividend payments from its taxable income. Dr. Feldstein figures that many middle-income families already have sufficient interest or dividend income to reach that $400 level. So the tax saving is a windfall gain that would not encourage much additional savings. He would rather allow people to exclude 50 percent of their interest and dividend income, with either no ceiling or a much higher limit. This would do more to stimulate savings.
As for the wealthy, the original Reagan plan to bring down the tax on unearned income from a maximum of 70 percent to 50 percent would have meant a loss of $4.5 billion in revenues. (That is a calculation based on a static outlook that assumes no boost in income through extra investment or shifted income sources.) So the decision of President Reagan to bring down that maximum rate more gradually means something less than a $2 billion revenue loss the first year. Thus, the extra income for the rich is much less important from the standpoint of stimulating savings than the tax benefits for the middle class.
Moreover, it should be remembered that only a minority of the wealthy pay anything like 70 percent on their earnings. Through various tax loopholes, the average real federal tax burden amounts to about one-third of income -- only a teeny bit higher than that for middle-income families.
The biggest benefit from cutting the high marginal taxes of the wealthy is that they may spend less effort trying to dodge taxes and more time on seeking the most productive investments.
Congress might do well to consider alternative routes to stimulating savings and investment when it considers the Reagan proposals.