Inequality, Social Discounting and Estate Taxation

43 Pages Posted: 6 Jul 2005 Last revised: 4 Sep 2010

See all articles by Emmanuel Farhi

Emmanuel Farhi

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Iván Werning

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2005

Abstract

To what degree should societies allow inequality to be inherited? What role should estate taxation play in shaping the intergenerational transmission of welfare? We explore these questions by modeling altruistically-linked individuals who experience privately observed taste or productivity shocks. Our positive economy is identical to models with infinite-lived individuals where efficiency requires immiseration: inequality grows without bound and everyone's consumption converges to zero. However, under an intergenerational interpretation, previous work only characterizes a particular set of Pareto-efficient allocations: those that value only the initial generation's welfare. We study other efficient allocations where the social welfare criterion values future generations directly, placing a positive weight on their welfare so that the effective social discount rate is lower than the private one. For any such difference in social and private discounting we find that consumption exhibits mean-reversion and that a steady-state, cross-sectional distribution for consumption and welfare exists, where no one is trapped at misery. The optimal allocation can then be implemented by a combination of income and estate taxation. We find that the optimal estate tax is progressive: fortunate parents face higher average marginal tax rates on their bequests.

Suggested Citation

Farhi, Emmanuel and Werning, Ivan, Inequality, Social Discounting and Estate Taxation (June 2005). NBER Working Paper No. w11408, Available at SSRN: https://ssrn.com/abstract=741556

Emmanuel Farhi

Harvard University - Department of Economics ( email )

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Ivan Werning (Contact Author)

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

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HOME PAGE: http://econ-www.mit.edu/faculty/iwerning

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