Boosting the Economy: Supply vs. Demand
Why anyone would give huge tax breaks to the wealthy eludes many of us. Some would argue that because the rich have used the freedoms of an economy to make much more money than they need, they should give back a larger share than those who are struggling. This is the very idea behind the progressive income tax in the United States: When income reaches higher brackets, the government taxes that excess at a higher rate. But under the logic of trickle-down theory, tax breaks for the wealthy benefit all.
To understand the reasoning behind this, let's take look at the history of the idea and the basic principle of supply and demand. In an economic slump, some say the government should make efforts to increase the supply (output or production) of an economy. Others argue the opposite: Lack of consumer demand is the root of the problem, and government should encourage consumer demand.
Nineteenth-century French economist Jean-Baptiste Say argued the former. Say's Law states that the way to economic growth is to boost production, and demand naturally follows. This flew in the face of the belief of the time, which was that a lack of money -- and thus lack of demand -- caused bad economic times [source: Skousen]. Say asserted that there will always be a demand for the right kind of products.
You could think of it this way: If there are people willing to work during a recession, they obviously want money in order to consume something. They must already have a demand that is not being met -- what they demand is either too expensive for them to afford or is not being produced. Producing in-demand products and driving down costs will create profit for the seller, and thus the means for him to satisfy his or her demand. Hence, production greases the wheels of the economy. This logic made sense to major thinkers of the time, including Thomas Jefferson and James Madison [source: Acton Institute].
A century later, the tide had turned in the United States. By the time the Great Depression hit in the 1930s, many legislators held the opposite view. The most notable opponent to Say's Law during this time was John Maynard Keynes, a British economist. Keynes argued that there are such things as overproduction and lack of demand, and the key is to increase demand rather than supply. Government should promote consumer demand rather than entrepreneurial production. When people consume more, they create more jobs and production.
Arguing that "in the long run, we are all dead," Keynes pushed for short-term fixes for immediate economic stability. He encouraged governments to adjust monetary policies (interest rates and the availability or amount of money circulating) and fiscal policies (government spending and taxes) to boost demand. Part of these adjustments includes increasing taxes on the rich and reducing taxes on the poor. While the rich would invest their money on making more products, the poor would be more likely to spend, consuming the oversupply that was the source of the problem [source: Wanniski]. Keynesian economics continued as the predominant philosophy in the United States for decades to come.
By the 1970s, trickle-down ideas were percolating in the minds of some economists who sought a return to Say's principles. Next, we'll learn how economists were able to garner support for trickle-down theory.