Implications of Present-biased Preferences on Inheritance Taxes

We model an economy where present biased preferences affect the bequest leaving decisions. Using Bequest in the Utility (BIU) setup, we show that the optimal inheritance tax rate under present bias can be derived in terms of estimable sufficient statistics. This optimal tax rate decreases with the level of temptation and a subsidy can be optimal at some level of bequests received. We then use the Barro-Becker Dynastic (BBD) setup to derive the expression for the optimal inheritance tax rates. We observe that if the agents internalize the taxes on the amount of bequest that they leave (sensitive generations), present bias and optimal tax rates are negatively related as in BIU, that is, providing an incentive by extending subsidies or lowering taxes is recommended to subside the effects of temptation. However, if agents ignore the taxes to be paid by their descendants on the inheritance left (ignorant generations), optimal tax rates increase with the level of present bias. This is because the present bias reduces the tax base and the rationale of providing incentives does not work anymore. Our calibration exercise supports all these theoretical findings.