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Optimal Inheritance Tax under Temptation

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  • Monisankar Bishnu
  • Cagri S. Kumru
  • Arm Nakornthab

Abstract

In this paper we derive the expression for optimal inheritance tax when agents' preferences are subject to temptation and self control problem. We consider a dynamic stochastic model as in Piketty and Saez (2013) where agents are heterogeneous in terms of bequest motives and labor productivities. In such a setup we show that the optimal inheritance tax rate decreases with the level of temptation, and thus it works as an incentive mechanism that leads to more bequests and makes succumbing to temptation less attractive. In fact, when temptation is acute, a subsidy may be justified at any percentile of bequest received. This holds independent of the variation in the models used in the literature as well as the assumption of labor elasticity. The study also reveals some interesting observations. Though from the point of view of incentives, this result has the same essence as in Krusell et al. (2010) where temptation justifies a subsidy on capital, we show that unlike their other policy prescription, the long run equilibrium does not demand a constant subsidy. Thus, even under temptation and self control issue, the standard Chamley - Judd result which recommends zero capital tax in the long run is still valid. However, in a setup that is comparable to Farhi and Werning (2010), our paper shows that in the presence of temptation and self control, if dynamic efficiency holds, optimality always requires a subsidy independent of whether social welfare function puts zero or positive direct weight on the children. This is in direct contrast to Piketty and Saez (2013). A calibration using the same micro data used by Piketty and Saez (2013) shows that the drop in inheritance tax is significant in the presence of temptation and self control.

Suggested Citation

  • Monisankar Bishnu & Cagri S. Kumru & Arm Nakornthab, 2016. "Optimal Inheritance Tax under Temptation," ANU Working Papers in Economics and Econometrics 2016-637, Australian National University, College of Business and Economics, School of Economics.
  • Handle: RePEc:acb:cbeeco:2016-637
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    File URL: https://www.cbe.anu.edu.au/researchpapers/econ/wp637.pdf
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    References listed on IDEAS

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    1. Per Krusell & Burhanettin Kuruşçu & Anthony A. Smith Jr., 2010. "Temptation and Taxation," Econometrica, Econometric Society, vol. 78(6), pages 2063-2084, November.
    2. Faruk Gul & Wolfgang Pesendorfer, 2004. "Self-Control and the Theory of Consumption," Econometrica, Econometric Society, vol. 72(1), pages 119-158, January.
    3. Thomas Piketty & Emmanuel Saez, 2013. "A Theory of Optimal Inheritance Taxation," Econometrica, Econometric Society, vol. 81(5), pages 1851-1886, September.
    4. Emmanuel Farhi & Iván Werning, 2010. "Progressive Estate Taxation," The Quarterly Journal of Economics, Oxford University Press, vol. 125(2), pages 635-673.
    5. John E. Stovall, 2010. "Multiple Temptations," Econometrica, Econometric Society, vol. 78(1), pages 349-376, January.
    6. Wojciech Kopczuk, 2013. "Incentive Effects of Inheritances and Optimal Estate Taxation," American Economic Review, American Economic Association, vol. 103(3), pages 472-477, May.
    7. Esteban, Susanna & Miyagawa, Eiichi & Shum, Matthew, 2007. "Nonlinear pricing with self-control preferences," Journal of Economic Theory, Elsevier, vol. 135(1), pages 306-338, July.
    8. DeJong, David N. & Ripoll, Marla, 2007. "Do self-control preferences help explain the puzzling behavior of asset prices?," Journal of Monetary Economics, Elsevier, vol. 54(4), pages 1035-1050, May.
    9. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-622, May.
    10. Eddie Dekel & Barton L. Lipman & Aldo Rustichini, 2009. "Temptation-Driven Preferences," Review of Economic Studies, Oxford University Press, vol. 76(3), pages 937-971.
    11. Drew Fudenberg, 2006. "Advancing Beyond Advances in Behavioral Economics," Journal of Economic Literature, American Economic Association, vol. 44(3), pages 694-711, September.
    12. Eddie Dekel & Barton L. Lipman, 2012. "Costly Self‐Control and Random Self‐Indulgence," Econometrica, Econometric Society, vol. 80(3), pages 1271-1302, May.
    13. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
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    Keywords

    Inheritance tax; Temptation; Self-control; Wealth mobility;

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