Do Capital Income Tax Cuts Trickle Down?

Reductions in the capital income tax rate generally stimulate investment and raise the marginal product of labor and the wage rate. Hence, it is often argued that cutting capital income taxes benefits capital owners and all workers. This result, however, depends on how government manages debt to maintain budget solvency. This paper analyzes the distributional effects of capital tax cuts, where endogenous adjustments in other tax rates are precluded. When productive public investment or transfers to liquidity–constrained workers are reduced, it finds that the trickle–down effect may not hold. This paper also demonstrates a well–known fallacy: tax liability changes are a poor proxy for welfare changes.