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Inequality, Social Discounting and Estate Taxation

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  • Emmanuel Farhi
  • Ivan Werning

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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11408.

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Date of creation: Jun 2005
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Publication status: published as Farhi, Emmanuel and Ivan Werning. “Inequality and Social Discounting.” Journal of Political Economy 115, 3 (June 2007).
Handle: RePEc:nbr:nberwo:11408

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  1. Thomas, Jonathan & Worrall, Tim, 1990. "Income fluctuation and asymmetric information: An example of a repeated principal-agent problem," Journal of Economic Theory, Elsevier, vol. 51(2), pages 367-390, August.
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Cited by:
  1. Zheng Song & Kjetil Storesletten & Fabrizio Zilibotti, 2007. "Rotten Parents and Disciplined Children: A Politico-Economic Theory of Public Expenditure and Debt," 2007 Meeting Papers 685, Society for Economic Dynamics.
  2. Grossmann, Volker & Strulik, Holger, 2008. "Should Continued Family Firms Face Lower Taxes Than Other Estates?," Hannover Economic Papers (HEP) dp-387, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  3. Juan Carlos Cordoba & Genevieve Verdier, 2005. "Lucas vs. Lucas: On Inequality and Growth," Macroeconomics 0511021, EconWPA.
  4. Valeria De Bonis & Luca Spataro, 2010. "Social discounting, migration, and optimal taxation of savings," Oxford Economic Papers, Oxford University Press, vol. 62(3), pages 603-623, July.
  5. Narayana R Kocherlakota, 2005. "Advances in Dynamic Optimal Taxation," Levine's Bibliography 784828000000000518, UCLA Department of Economics.
  6. Juan Carlos Cordoba & Geneviève Verdier, 2007. "Lucas vs. Lucas," IMF Working Papers 07/17, International Monetary Fund.
  7. Spataro, Luca & De Bonis, Valeria, 2008. "Accounting for the "disconnectedness" of the economy in OLG models: A case for taxing capital income," Economic Modelling, Elsevier, vol. 25(3), pages 411-421, May.
  8. Yuzhe Zhang, 2005. "Dynamic contracting, persistent shocks and optimal taxation," Working Papers 640, Federal Reserve Bank of Minneapolis.

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