The basic premise behind the economic stimulus packages put together by the federal government in recent years is that if the masses have money they will spend it. When they spend it, their money trickles up the corporate chain where it can be reinvested back into the economy through to grow businesses and, ultimately, lead to more jobs and increased salaries. At the same time, some tax rates are raised to recapture federal spending through taxation.

Does it work? Let’s take an example. In 2009, I bought a home and received a first time homebuyer credit (stimulus). Initially, that credit was deposited into a savings account. Over time, however, we used that money to replace the windows in our home, making it more energy efficient, and remodeled the kitchen, doing all the fabrication work myself.

Someone had to make the windows and install them. And someone had to make the plywood and materials for our kitchen cabinets and countertop, transport them to the store, and sell them at the local retail level. In theory, the credit we received did trickle up through the economy.

However, most of the goods we purchased (not sure about the windows) were manufactured on foreign soil. So other than profit to the store, the cost of the goods left our country.

Added to that, many global corporations with domestic operations or headquarters have increasingly utilized off shore strategies to shelter income from taxation. So the money trickled up, but some of it left our shores to foreign manufacturers and some of it was sheltered from taxation.

This means a good portion of the funds that trickled up are out of reach of federal taxation (will not replenish funds used in the stimulus) and were not reinvested into the economy, either because they stayed off shore or they were kept was profit.

Trickle up assumes that every dollar the government pumps into the economy will eventually work to expand businesses, jobs and salaries which will eventually replenish government spending through taxation. But when much of the money goes to pay for imports and is sheltered from taxation in off shore entities, trickle up fails to restart the economy or replenish government coffers.

If it created more jobs on domestic soil and kept more of the money on domestic soil, then trickle up economics would probably have been more successful at restarting the stalled economic engine. And it would have created long-term, sustainable growth, after which the government could withdraw its hand and leave the economy to run on its own power. Instead, we are still seeing artificial intervention through, as an example, zero or near zero interest rates at the Federal Reserve.

The design of trickle up economics is to put more money into the hands of the very wealthy and trust that they will reinvest the additional wealth in domestic production. But it only works if the money trickling up stays within our borders and is available for taxation.

Trickle down is equally a government economic stimulus package. The thrust behind trickle down economics is that more money in the hands of the very wealthy will lead to increased investment in domestic production. However, the approach is different.

Trickle down depends on tax cuts and subsidies targeted toward businesses and the very wealthy. To the extent low to middle income families enjoy tax cuts and more discretionary income, we’re back in the same boat as trickle up economics so far as creating jobs on foreign soil unless the goods they purchase are manufactured on domestic soil.

The difference is that trickle down primarily offers benefits to business operations on domestic soil. The plan encourages growth here at home. Expansion of businesses means more production and more jobs of many kinds in various phases of production. More jobs mean higher income among low to middle income families, resulting in – you guessed it – a jump in tax revenue.

In the end, both trickle up and trickle down depend on large businesses and the very wealthy to reinvest stimulus money back into the economy, but they approach it differently. Trickle up puts money in local hands first which eventually works its way to the top, where it is reinvested. Trickle down starts at the top where it is invested and works its way down to the local level. 

All things being equal, trickle down encourages more money to stay on domestic soil. For example, a government stimulus package may award millions of dollars for road construction on domestic soil. This guarantees jobs are created here at home, leading to higher incomes (and more tax revenue) and increased spending (and more tax revenue). The key risk with either approach is whether the businesses receiving the stimulus will actually invest in increased production on domestic soil. Policy can be established to restrict those who will receive stimulus under the trickle down approach to target businesses and very wealthy who will invest in domestic production. This is not possible with trickle up because government cannot control where the money ultimately ends up.

But given all this, the only reason any economic stimulus packages are used in the first place is when either businesses or local people become crippled. These situations represent an economic imbalance, and government decides to intervene to bring things back to the middle. It doesn’t always work and is definitely not fool proof. The better approach is for government not to intervene at all or to exercise restraint when deciding to get involved.
 


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    Climbing the Money Tree


    Author

    R. Joseph Ritter, Jr. CFP® is a CERTIFIED FINANCIAL PLANNER(TM) and founder of Zacchaeus Financial Counseling, Inc., a non-profit organization providing financial planning services to low-income households and households experiencing financial strain.

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