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Do Capital Income Tax Cuts Trickle Down?

Reductions in the capital income tax rate generally stimulate investment. A higher capital stock, in turn, raises 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. When productive public investment or transfers to liquidity-constrained workers are reduced, 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.

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Paper provided by Institute of Economics, Academia Sinica, Taipei, Taiwan in its series IEAS Working Paper : academic research with number 07-A005.

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Length: 22 pages
Date of creation: May 2007
Date of revision:
Handle: RePEc:sin:wpaper:07-a005
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  1. Alan J. Auerbach, 2005. "Who Bears the Corporate Tax? A review of What We Know," NBER Working Papers 11686, National Bureau of Economic Research, Inc.
  2. Yongsung Chang & Sun-Bin Kim, 2006. "From Individual To Aggregate Labor Supply: A Quantitative Analysis Based On A Heterogeneous Agent Macroeconomy ," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 47(1), pages 1-27, 02.
  3. N. Gregory Mankiw & Matthew Weinzierl, 2005. "Dynamic Scoring: A Back-of-the-Envelope Guide," Harvard Institute of Economic Research Working Papers 2057, Harvard - Institute of Economic Research.
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  8. Eissa, Nada & Liebman, Jeffrey B, 1996. "Labor Supply Response to the Earned Income Tax Credit," The Quarterly Journal of Economics, MIT Press, vol. 111(2), pages 605-37, May.
  9. David Altig, 2001. "Simulating Fundamental Tax Reform in the United States," American Economic Review, American Economic Association, vol. 91(3), pages 574-595, June.
  10. David Aschauer, 1988. "Does public capital crowd out private capital?," Staff Memoranda 88-10, Federal Reserve Bank of Chicago.
  11. Cushing, Matthew J, 1992. "Liquidity Constraints and Aggregate Consumption Behavior," Economic Inquiry, Western Economic Association International, vol. 30(1), pages 134-53, January.
  12. Altonji, Joseph G, 1986. "Intertemporal Substitution in Labor Supply: Evidence from Micro Data," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages S176-S215, June.
  13. Jones, John Bailey, 2002. "Has fiscal policy helped stabilize the postwar U.S. economy?," Journal of Monetary Economics, Elsevier, vol. 49(4), pages 709-746, May.
  14. Christopher J. Erceg & Luca Guerrieri & Christopher Gust, 2005. "Expansionary Fiscal Shocks and the US Trade Deficit," International Finance, Wiley Blackwell, vol. 8(3), pages 363-397, December.
  15. Aschauer, David Alan, 1985. "Fiscal Policy and Aggregate Demand," American Economic Review, American Economic Association, vol. 75(1), pages 117-27, March.
  16. David Aschauer, 1988. "Is public expenditure productive?," Staff Memoranda 88-7, Federal Reserve Bank of Chicago.
  17. Christopher J. Erceg & Luca Guerrieri & Christopher Gust, 2005. "Expansionary fiscal shocks and the trade deficit," International Finance Discussion Papers 825, Board of Governors of the Federal Reserve System (U.S.).
  18. Shinichi Nishiyama & Kent Smetters, 2005. "Consumption Taxes and Economic Efficiency with Idiosyncratic Wage Shocks," Journal of Political Economy, University of Chicago Press, vol. 113(5), pages 1088-1115, October.
  19. Hoynes, Hilary Williamson, 1996. "Welfare Transfers in Two-Parent Families: Labor Supply and Welfare Participation under AFDC-UP," Econometrica, Econometric Society, vol. 64(2), pages 295-332, March.
  20. Arnold C. Harberger, 1962. "The Incidence of the Corporation Income Tax," Journal of Political Economy, University of Chicago Press, vol. 70, pages 215.
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