Who Gets Utility from Bequests? the Distributive and Welfare Implications for a Consumption Tax

By Fried, Barbara H. | Stanford Law Review, April 1999 | Go to article overview

Who Gets Utility from Bequests? the Distributive and Welfare Implications for a Consumption Tax


Fried, Barbara H., Stanford Law Review


Private savings which are transferred intergenerationally through bequests make up a substantial portion of the U.S. capital stock. Most of these bequests do not get spent down by heirs and in fact usually increase in size as they are transferred to successive generations. In addition, bequests are overwhelmingly concentrated among the very wealthy. With this backdrop, Professor Barbara Fried engages in two related inquiries: First, who derives utility from bequests (donors, heirs, successive generations)? Second, what implications does this have for projecting the winners and losers from changing the taxation of savings, specifically in a shift from the income tax to a consumption tax? In order to determine who gains utility from bequests, Professor Fried first analyzes the various motives for bequest savings. These motives ,include the altruistic model, in which the donor gives out of generosity towards family members; the precautionary savings model, in which consumers save as a hedge against unforeseen contingencies and then bequeath whatever they do not consume; and the exchange model, in which a parent bequeaths money to a child in exchange for the child's care and services as the parent grows older. Professor Fried concludes that, under most theories of bequest motives, the level of bequests will increase under a consumption tax. For bequests that are disguised exchanges, the resulting increase in bequests will be used to finance a higher level of preclusive consumption for the donor generation, thereby generating utility for the donor generation only. For bequests motivated by altruistic and precautionary concerns, in contrast, the donor realizes at least a portion of the utility from bequest savings in a nonpreclusive form. As a result, any increase in bequests will generate increased utility for both donor and donee. A model that takes into account the double-level utility gains from increased bequest savings is likely to magnify the aggregate welfare gains from shifting to a consumption tax, as compared to the results reported by traditional models. It is also likely to magnify the distributional benefits of such a shift to the wealthiest five percent of Americans, who account for the majority of bequest savings.

INTRODUCTION

Private savings ultimately destined for intergenerational transfer, through inter vivos gifts or bequests, account for a very substantial percentage of the U.S. capital stock at any one time. Estimates of the percentage range from 15 percent to as high as 70 percent, and average about 50 percent. In addition, bequests appear to be a luxury good--that is, they are heavily concentrated (as a percentage of lifetime income) among the very wealthy (the top quintile in lifetime income, and even more dramatically the top 5 percent).(2) Consistent with that finding, the data show small positive elasticities for bequests with respect to changes in lifetime earnings throughout most of the income range, and very high positive elasticities for the top quintile in lifetime earnings.(3) The data indicate that most bequests never get consumed by heirs--indeed, most people who inherit money leave a significantly larger estate to their own heirs than they were left (measured in real dollars).(4) All of this raises the question: What is all this money doing out there, if it is never spent? Who, across generations of a family linked by gifts and bequests, actually derives utility from these transfers and how?

The immediate impetus for the question derives from how we account for the distributional and welfare effects of changing the tax treatment of savings, such as by adopting a consumption tax in place of our existing income tax. A consumption tax lowers the effective tax rate on savings, as compared to our existing income tax. It is generally agreed that a lower tax rate on savings will generate aggregate welfare gains to society, by reducing the tax-induced intertemporal distortions in people's consumption choices and by increasing private savings available for productive investment, although the extent of these gains is hotly contested. …

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