How Do Income and Bequest Taxes Affect Income Inequality? The Role of Parental Transfers
Chih-Chin Ho Ching-Yang Lin Cheng-Tao Tang
This paper studies how income and bequest taxes affect income inequality. We firstly explore this relationship empirically using a panel of 20 OECD countries from 1980 to 2008. The data shows that an increase of income taxation tends to strengthen income inequality, while the inequality effect of bequest taxation is ambiguous. In order to explain these findings, we develop an overlapping generation model with inter-generational transfers. Altruistic parents face the joint decision of making educational investment and leaving financial bequests. A change in tax structure will affect both asset allocation decision and wealth transmission, which in turn governs the dynamics of human capital accumulation and determines the net tax effects on equilibrium income distribution. We show these tax effects on income inequality analytically, and examine aggregate effects with numerical experiments. We find that the predictions of our model are consistent with data patterns.