Wealth Inequality, Family Background, and Estate Taxation

This paper provides two main contributions. First, it proposes a new theory of wealth inequality that merges two sources of inequality previously proposed: bequests motives and inheritance of ability of across generations, and an earnings process that allows for more earnings risk for the richest. Second, it uses our calibrated framework to study the importance of parental background and the effects of changing estate taxation on inequality, aggregate capital accumulation, intergenerational mobility, welfare, and on family background as a source of inequality. Our calibrated model generates realistically skewed distributions for wealth, earnings, and bequests, and a correlation of lifetime earnings and wealth at retirement that is close to that in the data and is thus a good laboratory to use to study these questions. We find that parental background is a crucial determinant of one's expected lifetime utility. We also find that increasing estate taxation from its effective levels observed over many years, to levels that are closer to the statutory ones observed in year 2000, would significantly reduce wealth concentration in the hands of the richest few and the role of parental background in determining one's lot in life. The implied welfare gains of such a policy would be positive for 71% of the population. For those experiencing losses, their loss would be a one-time cost of the order of 11% of average income.