Estate Taxation and Human Capital with Information Externalities

Abstract

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, resulting in a higher number of skilled workers, and in many cases, increased wages and output. In a parametrized model, I establish that the optimal estate tax rate is significantly above zero.