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.