Inheritance Taxation with Agents Differing in Altruism

We analyze a tax reform that consists in a shift from capital income tax towards inheritance tax, in a second-best world where the government needs to implement distortive taxes in order to finance public spendings. To do so, we consider a two-period overlapping generation model with rational altruism à la Barro, where the population consists of two types of dynasties that differ in altruism. With inelastic labor supply, the tax reform increases welfare of the less altruistic dynasties, but decreases welfare of the most altruistic ones. We then extend the model introducing elastic labor supply and home production, considering that the old can transfer time to their offspring to help them in their domestic tasks. In steady state, the tax reform is Pareto-improving if, simultaneously, initial net wages are low and substitutability between consumption of market goods and time for home production is high. Under these sufficient conditions, the tax reform leads to an increase in labor supply that allows for efficiency gains. A numerical example illustrates that the tax reform also achieves a Pareto improvement along the transitional dynamics.