This paper generates two main contributions. First, it provides a new theory of wealth inequality that merges two empirically relevant forces generating inequality: bequest motives and inheritance of ability across generations; and an earnings process that allows for more earnings risk for the richest. Second, it uses the resulting calibrated framework to study the effects of changing estate taxation. Increasing the estate tax reduces the wealth concentration in the hands of the richest few and the economic advantage of being born to a rich and super-rich family at the cost of reduced aggregate capital and output. However, all of these effects are quite small. In contrast, increasing estate taxation can generate a significant welfare gain to a newborn under the veil of ignorance, but this comes at a large welfare cost for the super-rich.
Bibliographical noteFunding Information:
De Nardi acknowledges support from the ERC , Grant 614328 “Savings and Risks,” and from the ESRC through the Centre for Macroeconomics. We thank Francesco Caselli, Helen Koshy, Ananth Seshadri, Gianluca Violante, Sevin Yeltekin, and several participants at many conferences and seminars for comments. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research, any agency of the Federal Government, or the Federal Reserve Bank of Chicago.
© 2015 The Authors.
- Earnings shocks
- Estate taxation
- Parental background
- Wealth inequality