Tax reductions enacted in 2001-2004 reduce the effective tax rate
on capital income in several different ways. Taxes on capital arise
from individual taxes on dividends, interest, capital gains, and
income from non-corporate businesses (proprietorships and
partnerships). Reductions in marginal tax rates, as well as some
tax benefits for business, reduce these taxes. Taxes on capital
income also arise from corporate profits taxes, which are affected
not only by rate reductions but also by changes to provisions
affecting depreciation, interest deductions, other deductions and
credits. Finally, taxes can be imposed on capital income through
the estate and gift tax. Tax cuts on capital income through capital
gains rate reductions, estate and gift tax reductions, and dividend
relief are estimated to cost about $57 billion per year, with about
half that amount attributable to the estate and gift tax. Lower
ordinary tax rates also affect income from unincorporated
businesses. These tax cuts are temporary and proposals to make some
or all of them permanent are expected. Bonus depreciation appears
less likely to be extended. While there are many factors used to
evaluate the effects of these tax revisions, one of them is the
distributional effect. This report addresses those distributional
issues, in the context of behavioral responses. Data suggest that
taxes on capital income tend to fall more heavily on high-income
individuals. All types of capital income are concentrated in
higher-income classes. For example, the top 2.8% of tax returns
(with adjusted gross income over $200,000 in 2009) have 26% of
income, 19% of wages, 39% of interest, 39% of dividends, and 57% of
capital gains. Taking into account a very broad range of capital
assets, a 2012 Treasury study found that the top 1% of the
population has about 19% of total income and about 12% of labor
income, but receives almost half of total capital income. Estate
and gift taxes are especially concentrated in the higher incomes:
prior to the tax cuts enacted in 2001-2004, only 2% of estates paid
the estate tax at all. If there is a significant reduction in
savings in response to capital income taxes, in the long run the
tax could be shifted to labor and thus become a regressive tax.
Some growth models are consistent with such a view, but generally
theory suggests that increases in taxes on capital income could
either decrease or increase savings, depending on a variety of
model assumptions and particularly depending on the disposition of
the revenues. There are also many reasons to be skeptical of these
models, which presume a great deal of skill and sophistication on
the part of individuals. New models of bounded rationality suggest
that taxes on capital income are likely to have no effect or
decrease saving, as individuals rely on common rules of thumb such
as saving a fixed fraction of income and saving for a target.
Empirical evidence in general does not suggest significant savings
responses, as savings rates and pre-tax returns to capital have
been relatively constant over long periods of time despite
significant changes in tax rate. If capital income taxes do not
reduce saving, these taxes fall on capital income and add to the
progressivity of the income tax system.
General
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