How do Inheritances Shape Wealth Inequality? Theory and Evidence from Sweden

Abstract

A recent literature has found that inheritances reduce relative measures of wealth inequality. Theoretically, we show that this surprising finding stems from high intergenerational wealth mobility or low inheritance inequality. Empirically, we show that this finding is only true in the short run using Swedish administrative data and exploiting randomness in the timing of death. The inheritance effect on wealth inequality is reversed within a decade due to less wealthy heirs depleting their inherited wealth in contrast to more affluent heirs. Investigating mechanisms behind this depletion, we find that inheritances generate a roughly constant increase in annual non-labor income. 60% of this increase is allocated to consumption of goods (half of which consists of car consumption) in the first years, compared to 80% in later years. The remaining labor supply responses reflect a considerable albeit declining inheritance labor-supply elasticity. In a second quasi-experimental design, we demonstrate that large windfall inheritances due to a inheritance tax repeal were sustained over time. Our findings suggest that inheritance taxation increases short-run wealth inequality but reduces it in the long run solely through taxation of very large inheritances.