Estate Taxation And Human Capital With Information Externalities

This paper investigates the effects of estate taxation when firms cannot directly observe worker skill levels. Imperfect labor market signaling gives rise to an information externality that causes workers to free-ride off of others’ human capital acquisition. Inherited wealth exacerbates the information externality because risk averse workers with larger inheritances exert less effort to acquire skills. By reducing these inheritances, an estate tax induces greater skill acquisition effort and increases the number of skilled workers. In a quantitative model with employer learning and capital accumulation, the optimal estate tax is significantly above zero, increases wages and output, and benefits a large majority of households.