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

Abstract

Inheritances reduce relative measures of wealth inequality according to recent evidence from several countries. Using a theoretical model and Swedish administrative data, we first show that this counter-intuitive finding can be explained by high intergenerational wealth mobility and low inheritance inequality relative to wealth inequality. We then exploit two quasi-experiments: randomness in the timing of death and an inheritance tax repeal. We find that the equalizing effect of inheritances is short-lasting and reverted within a decade since less wealthy heirs deplete their inherited wealth rapidly in contrast to more affluent heirs. This depletion represents a constant reduction in annual savings equivalent in size to 10% of the average inheritances amount. 70% of this additional an- nual non-labor income are allocated to consumption (half of it is car purchases) in the first years, compared to 90% in later years. The remaining 30% (or 10%) reflect a considerable albeit declining labor supply elasticity with respect to inheritances. Taken together, our findings suggest that inheritance taxation can reduce long-run wealth inequality solely through the taxation of very large inheritances.