About estate subsidies and capital income taxation

There is an endless debate about estate taxation, especially in the United States. One side wants to repeal it because it discourages entrepreneurship, the other side wants to expand it, for fairness' sake. Here comes a paper that claims that both sides are wrong. Estates should be subsidized.

Carlos Garriga and Fernando Sánchez-Losada are the ones making this surprising claim. The logic is the following. Imagine that there are three potential sources of taxation: estates, capital income and labor income. You want to optimize the tax mix in order to minimize the distortions from raising taxes and maximize equity as measured by the distribution of wealth across agents. Factor also in that there is some cross-generational altruism and that one cannot bequest more than one has. One also has to realize that bequest have an important positive externality that the donor only partially takes into account: its effect on the recipient. Logically, the donor needs to be encouraged, hence the estate subsidy. But this needs to be financed somehow, hence the capital income tax. It is usually found that capital income should not be taxed, but here the pressure to raise taxes is too strong. In fact, capital income tax is significantly higher than labor income tax.

All this is done with a model that gets reasonably close to mimicking the existing distribution of skill, income and wealth in the population. Garriga and Sánchez-Losada even look into tax progression in their analysis, but qualitative results remain with constant tax rates. What I learned from this is that despite equity concerns, one has to factor in that people leave too little bequests. And that the combination of estate subsidy with capital income taxation essentially alters the intertemporal profile of wealth holding to a more egalitarian one.