Incentive Effects of Inheritances and Optimal Estate Taxation. Kopczuk, W. American Economic Review: Papers & Proceedings, 103(3):472–477, 2013. ![Incentive Effects of Inheritances and Optimal Estate Taxation [link]](https://bibbase.org/img/filetypes/link.svg "link")
Link doi abstract bibtex Estate taxation is a policy topic of continued interest. Despite rumors of its demise in the United States where it was put on life support as the result of partial repeal in 2010, its future now seems more alive. However, the economic literature on taxation of estates is surprisingly inconclusive (see Kopczuk forthcoming for a recent survey). When generations are linked by altru-ism and the objective function respects dynas-tic preferences, taxation of estates is analogous to taxation of saving with the identical baseline result of no taxation. In a recent paper, Farhi and Werning (2010) allow for the social planner to value welfare of the children's generation separately from the dynastic welfare and show that the corresponding externality due to insufficient giving should be addressed by policy that subsidizes bequests (albeit in a "progressive" manner). In a very stylized model, Kopczuk (2001) focuses on steady state policies in the presence of non-altruistic bequest motives and shows that the estate tax is a useful instrument. Piketty and Saez (2012) analyze linear taxation and many different extensions of a steady state setup and generally find a role for taxation of bequests. The objective of this note is to clarify economic assumptions that determine the optimal tax treatment of bequests. I consider a joy-of-giving bequest motive and two generations: parents and children. The model captures two EstatE and Gift taxation ‡ key considerations. First, within any particular family, bequests have a positive externality because they benefit both parents and children. One can view this aspect as a manifestation of the source of the common argument against taxing estates: they reflect generosity not just self-interest. At the same time, bequests generate inequality in the children's generation. While inequality induced by bequests has its ultimate source in the initial conditions (skill distribution of parents), the key point is that tax on bequests plays an independent redis-tributive role within the offspring generation. This is made stark by the joy-of-giving model that eliminates interactions between the two generations. In contrast, the standard altruistic model would assume that parents internalize incentives of children so that there would be no distinction between redistribution among dynasties, parents, and children. I show that the optimal bequest tax formula is simple and intuitive and it reflects these two forces: correction of an externality that pushes toward subsidies and relaxing of children's incentive constraints due to an income effect that pushes toward taxation. The relative strength of these two effects determines the optimal sign and magnitude of the tax. I speculate that the optimal tax structure may in fact involve subsidies at the bottom and taxation at the top of the distribution. I further suggest that inheritance rather than estate tax may be a more suitable instrument here, because all determinants of the optimal policy reflect characteristics of a child. The results also highlight the key empirical parameters of interest. It is the magnitude of the income effect due to bequests that influences the optimal tax rate. In contrast, under the simple structure assumed in this paper, the direct effect of taxation on bequests does not enter the optimal tax formula.
@article{Kopczuk2013,
title = {Incentive Effects of Inheritances and Optimal Estate Taxation},
author = {Kopczuk, Wojciech},
year = {2013},
journal = {American Economic Review: Papers \& Proceedings},
volume = {103},
number = {3},
pages = {472--477},
doi = {10.1257/aer.103.3.472},
url = {https://www.aeaweb.org/articles?id=10.1257/aer.103.3.472},
abstract = {Estate taxation is a policy topic of continued interest. Despite rumors of its demise in the United States where it was put on life support as the result of partial repeal in 2010, its future now seems more alive. However, the economic literature on taxation of estates is surprisingly inconclusive (see Kopczuk forthcoming for a recent survey). When generations are linked by altru-ism and the objective function respects dynas-tic preferences, taxation of estates is analogous to taxation of saving with the identical baseline result of no taxation. In a recent paper, Farhi and Werning (2010) allow for the social planner to value welfare of the children's generation separately from the dynastic welfare and show that the corresponding externality due to insufficient giving should be addressed by policy that subsidizes bequests (albeit in a "progressive" manner). In a very stylized model, Kopczuk (2001) focuses on steady state policies in the presence of non-altruistic bequest motives and shows that the estate tax is a useful instrument. Piketty and Saez (2012) analyze linear taxation and many different extensions of a steady state setup and generally find a role for taxation of bequests. The objective of this note is to clarify economic assumptions that determine the optimal tax treatment of bequests. I consider a joy-of-giving bequest motive and two generations: parents and children. The model captures two EstatE and Gift taxation \textdaggerdbl{} key considerations. First, within any particular family, bequests have a positive externality because they benefit both parents and children. One can view this aspect as a manifestation of the source of the common argument against taxing estates: they reflect generosity not just self-interest. At the same time, bequests generate inequality in the children's generation. While inequality induced by bequests has its ultimate source in the initial conditions (skill distribution of parents), the key point is that tax on bequests plays an independent redis-tributive role within the offspring generation. This is made stark by the joy-of-giving model that eliminates interactions between the two generations. In contrast, the standard altruistic model would assume that parents internalize incentives of children so that there would be no distinction between redistribution among dynasties, parents, and children. I show that the optimal bequest tax formula is simple and intuitive and it reflects these two forces: correction of an externality that pushes toward subsidies and relaxing of children's incentive constraints due to an income effect that pushes toward taxation. The relative strength of these two effects determines the optimal sign and magnitude of the tax. I speculate that the optimal tax structure may in fact involve subsidies at the bottom and taxation at the top of the distribution. I further suggest that inheritance rather than estate tax may be a more suitable instrument here, because all determinants of the optimal policy reflect characteristics of a child. The results also highlight the key empirical parameters of interest. It is the magnitude of the income effect due to bequests that influences the optimal tax rate. In contrast, under the simple structure assumed in this paper, the direct effect of taxation on bequests does not enter the optimal tax formula.},
keywords = {Wealth Taxation}
}
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When generations are linked by altru-ism and the objective function respects dynas-tic preferences, taxation of estates is analogous to taxation of saving with the identical baseline result of no taxation. In a recent paper, Farhi and Werning (2010) allow for the social planner to value welfare of the children's generation separately from the dynastic welfare and show that the corresponding externality due to insufficient giving should be addressed by policy that subsidizes bequests (albeit in a \"progressive\" manner). In a very stylized model, Kopczuk (2001) focuses on steady state policies in the presence of non-altruistic bequest motives and shows that the estate tax is a useful instrument. Piketty and Saez (2012) analyze linear taxation and many different extensions of a steady state setup and generally find a role for taxation of bequests. The objective of this note is to clarify economic assumptions that determine the optimal tax treatment of bequests. I consider a joy-of-giving bequest motive and two generations: parents and children. The model captures two EstatE and Gift taxation ‡ key considerations. First, within any particular family, bequests have a positive externality because they benefit both parents and children. One can view this aspect as a manifestation of the source of the common argument against taxing estates: they reflect generosity not just self-interest. At the same time, bequests generate inequality in the children's generation. While inequality induced by bequests has its ultimate source in the initial conditions (skill distribution of parents), the key point is that tax on bequests plays an independent redis-tributive role within the offspring generation. This is made stark by the joy-of-giving model that eliminates interactions between the two generations. In contrast, the standard altruistic model would assume that parents internalize incentives of children so that there would be no distinction between redistribution among dynasties, parents, and children. I show that the optimal bequest tax formula is simple and intuitive and it reflects these two forces: correction of an externality that pushes toward subsidies and relaxing of children's incentive constraints due to an income effect that pushes toward taxation. The relative strength of these two effects determines the optimal sign and magnitude of the tax. I speculate that the optimal tax structure may in fact involve subsidies at the bottom and taxation at the top of the distribution. I further suggest that inheritance rather than estate tax may be a more suitable instrument here, because all determinants of the optimal policy reflect characteristics of a child. The results also highlight the key empirical parameters of interest. 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In contrast, the standard altruistic model would assume that parents internalize incentives of children so that there would be no distinction between redistribution among dynasties, parents, and children. I show that the optimal bequest tax formula is simple and intuitive and it reflects these two forces: correction of an externality that pushes toward subsidies and relaxing of children's incentive constraints due to an income effect that pushes toward taxation. The relative strength of these two effects determines the optimal sign and magnitude of the tax. I speculate that the optimal tax structure may in fact involve subsidies at the bottom and taxation at the top of the distribution. I further suggest that inheritance rather than estate tax may be a more suitable instrument here, because all determinants of the optimal policy reflect characteristics of a child. The results also highlight the key empirical parameters of interest. 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