The optimal inheritance tax in the presence of inv

Authors: Michel Strawczynski

Publish Date: 2014/05/07

Volume: 21, Issue: 4, Pages: 768-795

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Abstract

This paper provides an example aimed at calculating the optimal inheritance tax in a model in which inheritances are used to finance investment in education Two results are obtained 1 The optimal inheritance tax schedule includes a threshold estimated between 25 and 55 times percapita GDP This result holds for a Rawlsian social planner that maximizes the welfare of the poorest individual who does not leave bequests 2 Contrary to the result of a 100  tax on pure accidental bequests the optimal simulated tax rates are between 28  for the case of educational bequests and 57  for the case where educational and accidental bequests interact This range is in line with existing schedules in developed economiesI thank Oren Tirosh for his excellent research assistance Thanks to Johann Brunner Momi Dahan Stephen Zeldes Joseph Zeira Asaf Zussman and participants at seminars at Columbia Cornell Hertzlia the Hebrew University and the 69th Annual Congress of the International Institute of Public Finance held in Sicily for helpful comments Special thanks to two anonymous referees of the journal for excellent remarks and to Wojciech Kopczuk for his comments on the first draft of the paperLet us start by characterizing the poor dynasty Since individuals that belong to this dynasty do not receive a bequest they do not invest in education and their net wage is 1tau n mathrmu The corresponding point in Fig 3 is A which implies not investing in education at all Theoretically parents from this dynasty could ask for a loan However as shown by Galor and Zeira 1993 the cost of a loan increases with the amount borrowed since the tracking costs go up with the size of the loan In my model this feature implies that lambda 1 is higher than lambda 2 Thus asking for a loan would allow individuals from the poor dynasty to arrive to point C which implies an investment in education that is lower than X Consequently this investment is not enough for receiving the hourly wage of skilled labor even if they borrow and invest on education they would continue to receive the unskilled hourly wage Therefore this dynasty does not invest in educationFor the middle dynasty the education costs include borrowing costs that are not present for the rich dynasty this implies that lambda 2 lambda 3 Thus the middle dynasty is at point B and invests X which is on the edge of indifference to investing in education Clearly the second dynasty would be affected by the imposition of the inheritance tax at a rate t causing it to move to point F this move would imply an optimal investment in education that is lower than X and consequently it would not be enough for getting the skilled hourly wage Thus in this case the second dynasty would choose avoiding investment in educationNote that for the second dynasty there is a difference between the extensive and intensive margin At the extensive margin the existence of an inheritance tax implies receiving an amount that is lower than X and consequently the investment would result in the unskilled hourly wage This return is obtained also if the amount of money invested equals zero Thus at the extensive margin the second dynasty prefers not to invest in education Concerning the intensive margin the decision of the invested amount varies depending on the amount of available resources in particular if available resources are higher than X the second dynasty would invest in education even in the presence of an inheritance tax at the first dollar Moreover its investment would be higher than XThe rich dynasty receiving a high bequest would be at point D this implies investing in education Moreover note that this dynasty would invest in education even if there were a tax on bequests22 fe in point E represented by t as long as the tax did not reduce the return to education to a desired level of investment lower than XIn the model presented above I have assumed that the first generation of the second and third dynasties had enough resources so as to invest in education This assumption seems trivial concerning the rich third dynasty Concerning the middle class second dynasty I could have assumed alternatively that it starts the world as unskilled ie they receive a bequest that is lower than X Thus a detailed discussion of my assumptions is at place

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