4. Budget Deficits & Taxation: Taxes&Incentives Intergen. Wealth Mobility

Question 1

What is “wealth mobility”?

Answer 1

The ability of agents to change their economic status

Question 2

What does Thomas Piketty argue regarding optimal tax policy?

Answer 2

According to his model, the optimal policy would be to tax rich individuals a lot

(contrary to Chamley and Judd)

Question 3

Should we tax inheritances?

2 points

Answer 3

The answer depends on the goal:
- If the aim is to avoid the persistence of inequality the YES (rich should be taxed to distribute wealth more evenly)

• If the aim is to respect individual choices and maintain productive efficiency then NO (the rich work hard, and more work contributes to more GDP)

Question 4

What is the trade-off faced in the discussion over inheritance taxes?

Answer 4

Trade-off between social justice and individual efficiency

Question 5

What is the model adopted by Farhi & Werning (2010)?

5 points

Answer 5

2 periods

Parents work, consume and bequeath in period 1

Each parent replace by a child in period 2

Children only consume

Agents are heterogeneous and defined by productivity θ

Question 6

Give the formula for parents preferences in Farhi & Werning (2010)

Explain

Answer 6

u(c0) – h(n0/ θ0) + βu(c1)

Parents utility = their utility from consumption - utility cost of having to work + utility derived from their children’s welfare subject to level of altruism

Question 7

In Farhi & Werning (2010), what does a higher value of θ mean?

Answer 7

High θ => more productive => costs associated with working are less => individual works more => is able to obtain more consumption for them self and their child

Question 8

What is the budget constraint in Farhi & Werning (2010)s model?

Explain

Answer 8

c0 + c1 = n0

The amount that a parent consumes + what they give to their child = the work effort exerted

Question 9

Farhi & Werning (2010)s model has no government, what are the implications of this?

Answer 9

The market has “perfectly
consistent inequality”

i.e. agents that happen to be more productive will always have higher utility, rich parent give their inheritance to their kids who are automatically wealthier than other children

Question 10

What is the main issue in Farhi & Werning (2010)?

Answer 10

Productivity θ is not observed, therefore taxes cannot depend on an individuals productivity

Question 11

What is the social planners problem in Farhi & Werning (2010)?

Answer 11

To maximise the utility of both agents subject to:

• The aggregate resource constraint
• The minimum level of children’s utility
• Incentive compatibility constraints (the tax has to be reasonable/realistic)

Question 12

What are the key results of Farhi & Werning (2010)?

2 points

Answer 12

YES - we should tax inheritances

Optimal taxation on inheritances is positive and progressive

Question 13

On what does the answer to the question “should we tax inheritances?” depend?

Answer 13

Depends on what you consider to be a reasonable object to maximise i.e. what you consider to be most important in an economy