A Dynamic Analysis of Estate Tax Repeal

Abstract

This paper examines the effects of permanently repealing the estate tax on capital accumulation and output using two different approaches to modeling the economic distortions resulting from the estate tax. In the first approach, the estate tax acts as an additional tax on capital income. The estate tax rate can be converted into an annual accrual tax rate on capital income that leaves a household with the equivalent amount of after-tax bequest. Assuming the economy-wide marginal accrual estate tax rate equals 1.7 percent, repeal of the estate tax leads to a long-run increase in the capital stock of 1.8 percent when repeal is combined with contemporaneous reductions in lump-sum transfer payments. The capital stock increases by 0.9 percent if repeal is financed by increasing income tax rates in every year. The long-run increase in the capital stock would rise to 3.3 percent if the marginal accrual rate equaled 2.6 percent and lump-sum transfer payments declined annually with repeal of the estate tax.

In the second approach, bequests are taxed directly and the after-tax bequest is included in the household’s utility function in a manner consistent with what is known as the “joy of giving” bequest motive. Under this approach, the long-run capital stock declines when the estate tax is repealed, even when financed by contemporaneous reductions in lump-sum transfer payments. This decline is 0.7 percent when the initial marginal bequest tax rate equals the average rate of 20 percent, and the decline is 0.4 percent when the initial marginal bequest tax rate equals 41 percent.

Keywords: Estate tax, Dynamic analysis, Tax reform

JEL Classification: H24, H31