Optimal Inheritance Taxation under Uncertainty and Tax Frictions

The current literature in optimal inheritance taxation does not address two important issues. First, there is significant uncertainty surrounding the receipt of a bequest by heirs. This uncertainty can arise from complications in inheritance law, prospects of future taxes, and conflict among the recipients. Such factors can cause individuals to change how much they consume during their life and how much they leave for their heirs. Second, the costs associated with assessing taxable property and collecting taxes on that property can be significant.

The paper considers a non-overlapping generations model adapted from a 2013 paper by Thomas Piketty and Emmanuel Saez. In this model, utility maximizing individuals receive utility from consump- tion, labor, and bequests left to their heirs and government taxes inheritance and labor income in such a way that they can maximize social welfare through a fixed, redistributive lump sum. We focus on how changes in uncertainty, inheritance tax frictions, and labor- income tax frictions effect the optimal inheritance tax.

We find that an increase in uncertainty causes individuals to con- sume more and leave less for their heirs. This increased uncertainty also lowers the optimal inheritance tax. We also find that increasing the friction on bequest tax decreases the optimal bequest tax, and increasing the friction on labor income tax increases the optimal bequest tax.