Indirect Taxation and the Welfare Effects of Altruism on the Optimal Fiscal Policy

Abstract

This paper analyzes the welfare effects of altruism on the optimal fiscal policy. The existence of positive bequests links present and future generations in the economy. We show that these altruistic links provide a new role for indirect taxation (consumption and estate taxes) with important welfare implications. We use three different altruistic approaches (warm-glow, dynastic, and family) to illustrate how the presence of bequests in the budget constraint of the donee gives the government the ability to use indirect taxation to mimic lump-sum taxation and to implement the first-best outcome in the long-run. This channel is not present in economies without altruism, such as the infinite-lived consumer economy or the overlapping generations economy, where long-run welfare is suboptimal and indirect taxation is irrelevant.