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Should continued family firms face lower taxes than other estates?

  • Grossmann, Volker
  • Strulik, Holger

Taxes on estates and inheritances may induce heirs to discontinue family firms. Because firm dissolution incurs transaction costs, a preferential tax treatment of transferred family businesses seems to be desirable from a macroeconomic viewpoint. The support of dynastic succession, however, entails also a cost on the economy if firm continuation by less able heirs prevents entry into entrepreneurship. Here, we investigate analytically and quantitatively the trade-off between transaction costs saved and creative destruction prevented. We find that a unique general equilibrium exists at which, depending on the institutional setup, low-ability heirs either abandon (Type 1) or continue (Type 2) a family business. A calibration of the model with German data suggests that preferential tax treatment of family firms has severe negative consequences on macroeconomic performance if it causes a threshold crossing from Type 1 to Type 2 equilibrium. It also reveals that the descendants of less able entrepreneurs who were caused by continuation-friendly tax policy to keep a family business always lose relative to their status in an economy without such a policy.

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Article provided by Elsevier in its journal Journal of Public Economics.

Volume (Year): 94 (2010)
Issue (Month): 1-2 (February)
Pages: 87-101

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Handle: RePEc:eee:pubeco:v:94:y:2010:i:1-2:p:87-101
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505578

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