Tax reductions enacted in 2001 through 2004, as well as some under consideration, 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. Some of these provisions were originally to expire in 2010 or earlier but were extended for an additional two years. Further extensions are under consideration. Bonus depreciation was deliberately set to be temporary, and expired in 2004. It was reinstated in 2008 and extended on several occasions as a stimulus during the recent recession, but is not included in any current legislation. The largest of the reductions, measured by estimated revenue cost, is a one-year extension of the marginal individual rate reductions, which is estimated to cost approximately $94 billion. Other revenue losses include the estate and gift tax repeal at a cost $31 billion, and the reduction in tax rates on dividends and capital gains at a cost of approximately $26 billion. In addition to extensions of various tax reductions, income tax reform, including reform of corporate and business taxes, may be considered, which could also affect capital income tax burdens. Although many issues surround these tax changes, one of them is the extent to which they benefit higher- or lower-income individuals. The eventual consequences of these tax provisions depend on the behavioral responses to tax cuts, which also drive issues of incentive effects and economic growth. This report addresses these distributional issues, in the context of behavioral responses. The first section of this paper provides general data on the distribution of capital income of various types, as a background to discussing the incidence issues. The next section discusses how behavioral responses could alter the distributional effects, examining both shifts in the types of assets held and changes in savings rates. Capital income may be earned directly by individuals in operating their own businesses or as passive income from lending or investing in corporate stocks. Income from unincorporated businesses is not separated into labor and capital income, but the distribution of income of different types can be compared by examining passive capital income sources. There are three major types of passive capital income: interest on debt, dividends on corporate stock, and capital gains (which arise from the sale of stock and from the sale of other assets). Table 1 provides data on the distribution of this income. Table 1 demonstrates several aspects of the distribution of capital income. First, as in the case of all income, the distribution is very uneven, with larger shares accruing to very small portions of the population. For example, the under $30,000 adjusted gross income class has 48% of the returns but only 10% of income, 13% of wages, 18% of taxable interest income, 9% of taxable dividends and 3% of taxable capital gains. Those over $200,000 had 26% of income, 19% of wages, 39% of taxable interest income, 39% of taxable dividends, and 57% of taxable capital gains. Secondly, on the whole capital income is more concentrated among higher-income individuals than is wage income and the concentration varies by type. Capital gains are more heavily concentrated among higher-income individuals than is income from dividends, and dividends are more concentrated than interest. Higher-income individuals are more likely to be risk takers and invest in stocks and bonds so that both dividends and capital gains are more concentrated in higher-income classes than is interest income. The greater concentration of capital gains as compared to dividends may be partly due to the preference of higher-income individuals for growth stocks, partly due to the fact that a lot of interest is effectively reported as dividends because it is funneled through mutual funds, and partly due to the fact that sales of capital assets also reflects sales of real property (also concentrated in high-income classes). High-income individuals would also tend to prefer investments that would have otherwise been subject to higher individual tax rates, and so may be more concentrated in capital gains and stocks for that reason. (Although corporate source income is taxed more heavily than non-corporate income, this rate is essentially a flat rate and there is no tax benefit to higher-income individuals. At the personal tax level, however, high-income individuals benefit from the lower capital gains rates more than lower- and middle-income individuals, because of the higher spread between the ordinary and capital gains tax rate.) Note that there are also significant amounts of capital income that are not subject to tax. One such source of income, tax exempt municipal bonds, is reported in Table 1 . There are much larger amounts of interest held in pensions and IRAs; in fact about half of interest and dividends are not taxable for this reason. The implicit rent from owning consumer durables, most importantly owner occupied housing, is not subject to tax. If individuals did not change their behavior in response to a tax change, then the effect of tax cuts or increases for these types of income could be measured by applying the change in the tax rates to income. Cuts in capital gains tax would most favor higher-income individuals, but in general, all tax cuts on capital income are likely to benefit higher-income individuals. Table 1 does not contain any information about the estate and gift tax. However, the estate tax is highly concentrated among top asset classes, with only 2.1% of decedents paying estate taxes in 2000 (before the recent round of tax cuts). Table 1 also does not contain direct information about corporate source income, but since that income is ultimately received as dividends and capital gains, the data also suggest that corporate taxes, were there to be no behavioral response, would fall on higher-income individuals. Based on this distributional data, capital income taxes fall on higher-income individuals and contribute to the progressivity of the tax system. This analysis, however, is incomplete for two reasons: portfolio shifts and possible effects on savings behavior. Portfolio shifts are considered first. Holding aggregate assets as fixed, there is no behavioral response unless returns on different types of assets are taxed differently. In general, more assets will be allocated to those activities or forms of investment whose returns are favored by the tax system. In a classic economics article that focused on the response to a differential tax—in this case the corporate income tax—the analysis showed that the likely outcome of such behavioral response is that the burden of the tax falls on all owners of capital. This behavioral response arose from the migration of capital out of the more heavily taxed sector as the post-tax return falls, and into the more lightly taxed sector. As capital migrates, the sector with the reduced capital stock will experience a higher pre-tax return (because capital is relatively scarce compared to the other sectors), while the sectors with the increased capital stock will experience a lower pre-tax return. This process occurs until after-tax returns (adjusted for risk) are once again equated. Capital owners in the tax-favored sector bear part of the burden through lower pre-tax returns and capital owners in the taxed sector have some of the original burden reduced through higher pre-tax returns. This shifting effect can, however, only occur for the "normal" return to capital (the return earned by competitive firms); excess returns due, for example, to market power should be capitalized in the value of the firm: an increase in tax produces a one-time fall in value that falls on the current owners. Labor could benefit slightly or share some small part of the burden, but in general to examine the burden of, say the corporate tax, one would want to attribute the tax to owners of capital in general. Thus to determine the distribution across income classes it is necessary to determine the distribution of capital and labor income. A Treasury study estimates the distribution of capital, labor, and all income by population quintile (with some finer divisions at the top), as reported in Table 2 . This analysis confirms the earlier findings that suggest capital income is especially concentrated at high levels. The top 1% has more than 30% of capital income but only 10% of labor income. Thus while portfolio shifts should be taken into account in determining the burden of capital income taxes, since overall capital is concentrated towards higher-income individuals, a tax on capital income is likely to fall on higher-income individuals, even considering shifts in the allocation of capital. Hence, capital income taxes contribute to the progressivity of the tax system, even if they are applied at a flat rate (as is essentially the case of the corporate tax). There is one potential reservation to this argument, even in the context of a fixed savings rate, namely the effect of capital income taxation in an open economy. When capital is migrating across sectors, labor is also free to migrate as well as wages and prices change. When capital migrates abroad, however, labor does not have the same freedom. Thus it is possible that the burden of capital income tax shifts to labor for this reason. Indeed, in a very specific set of circumstances one can find that the entire burden of a tax imposed in one country is shifted to labor and since the share of labor income received by higher-income individuals is less than the share of total income, then capital income taxes would be regressive rather than progressive. The circumstances for this outcome, however, are very narrow: the tax must be applied on a territorial basis (that is, only applied to capital used in the country, not capital owned by the country's citizens), capital investments must be perfectly substitutable across different countries, the country must be a small country, products must be perfect substitutes, and there are no returns from market power. Moreover, there must be no response to a change in tax rates from the trading partners.