Optimal Income, Education, and Bequest Taxes in an Intergenerational Model

Abstract

This paper considers dynamic optimal income, education, and bequest taxes in a Barro-Becker dynastic setup. Parents can transfer resources to their children in two ways: First, through education investments, which have heterogeneous and stochastic returns for children, and, second, through nancial bequests, which yield a safe, uniform return. Each generation’s productivity and preferences are subject to idiosyncratic shocks. I derive optimal linear formulas for each tax, as functions of estimable sucient statistics, robust to underlying heterogeneities in preferences, and at any given level of all other taxes. It is in general not optimal to make education expenses fully tax deductible and the optimal education subsidy, income tax and bequest tax can co-move positively or negatively. I also show how to derive optimal formulas using \reform-specic elasticities that can be targeted to empirical estimates from existing reforms. I extend the model to an overlapping generations dynastic model to study the eects of credit constraints on optimal education subsidies. Finally, I solve for the fully unrestricted policies and show that, if education is highly complementary to children’s ability, it is optimal to distort parents’ trade-o between education and bequests and to tax education investments relative to bequests. JEL classication : H21, H23, I21