Taxing bequests and consumption in the steady state

We study the optimal tax system in a dynamic model where differences in wages induce differences in inheritances, and the transition from parent ability to child ability is described by a Markov chain. We characterize expected inheritances in the steady state and show that the Atkinson-Stiglitz result on the redundancy of indirect taxes does not hold in this framework. In particular, given an optimal income tax, a bequest tax as well as a consumption tax are potential instruments for additional redistribution. For the bequest tax the sign of the overall welfare e¤ect depends on the reaction of bequests and on inequality aversion, while for the consumption tax the sign is always positive because the distorting e¤ect is outweighed by the induced increase in wealth accumulation. A necessary condition for a positive welfare effect is the empirically validated relation that more able individuals on average have more able parents than less able individuals.