Bequests and Inheritances

The estate tax can influence the behavior of wealthy older individuals, even if it simply causes them to consult a professional estate planner in order to minimize estate tax liability. Other behavioral effects may include increased work effort and savings, increased charitable bequests, and decreased capital gains realizations.

First, since estate taxes directly reduce the amount of a parent's wealth actually received by an heir, they can lead to increased work effort and savings. A parent intending an heir to receive a specific dollar amount would have to save more (and perhaps work more) than if there were no estate taxes. Other parents could decide estate taxes are so high that it is impractical to leave any sizable bequests. This could lead to decreased savings and work effort among older individuals. It is extremely difficult to determine how significant either of these behavioral effects may be in practice.

Second, by exempting charitable bequests from taxation, the estate tax directly encourages such bequests. A simple example will illustrate why this is so. Suppose Susan is deciding how to allocate her estate, knowing it will face a marginal tax rate of 55 percent. She has allocated all of her estate except for $10,000, which could be given either to charity or to a cousin. If it is given to the cousin, the government will collect its share, leaving the cousin with only $4,500. If it is given to a charity, the charity will receive the entire $10,000. Many people choose the charity when confronted with this actual choice of giving $4,500 to an heir or $10,000 to charity. Several studies of this issue produced similar results. For example, Gerald Auten and David Joulfaian (1996) concluded that charitable gifts could be as much as 12 percent lower in a world without estate taxes.

Third, the fact that the appreciated value of capital assets (e.g., stocks and bonds) in an estate is not subject to capital gains or income taxes encourages older individuals not to sell such assets. The wealth associated with these assets will be subjected to the estate tax whether or not the asset is sold before death. But if an individual sells an asset before death, he or she will be liable for capital gains taxes on the appreciated value. The individual will then have less to bequeath. In contrast, an individual who does not sell an asset before death can bequeath the entire value of the asset. Economists continue to debate whether or not estate taxes actually encourage older individuals to hold capital assets longer than they should.

Finally, the behavioral effects of bequests themselves should be considered. Studies show that the larger the inheritance received by a person, the more likely he or she is to reduce the work effort, and perhaps even to retire. The effect, however, is relatively small. Joulfaian (1998) reported that among 1995 beneficiaries, only 9 percent of unmarried bequest recipients had quit work three years later. Of couples with both spouses working when they received an inheritance, 98.5 percent still had at least one spouse working three years later. This result likely understates the effect of bequests because it cannot indicate whether retirement was accelerated but did not occur within the three-year study period.