Bequest Motives and the Annuity Puzzle

Few retirees annuitize any wealth, a fact that has so far defied explanation within the standard framework of forward-looking, expected utility-maximizing agents. Bequest motives seem a natural explanation. Yet the prevailing view is that people with plausible bequest motives should annuitize part of their wealth, and thus that bequest motives cannot explain why most people do not annuitize any wealth. I show, however, that people with plausible bequest motives are likely to be better off not annuitizing any wealth at available rates. The evidence suggests that bequest motives play a central role in limiting the demand for annuities.     

Estate tax and lifetime income inequality

This paper constructs a heterogeneous, intertemporal general equilibrium framework which integrates both intended and unintended bequest motives to examine the long-run effects of an estate tax on the inequality of lifetime income. The results are ambiguous in general and sensitive to the type of transfer motive involved. We find that in the purely intended bequest case, an estate tax increases the steady-state inequality of net lifetime income in the case where people's elasticity of intertemporal substitution is greater than one. However, in the purely unintended bequest case, the effect of an estate tax on inequality is dependent on the probability of survival.     

Optimal annuitization, uncertain survival probabilities, and maxmin preferences

We consider a life-cycle model with bequest motives, and assume that the individual does not know his/her survival probability and has maxmin utility preferences; we show that it is optimal not to annuitize but to purchase pure life insurance policies instead.     

THE VANISHING BEQUEST TAX: THE COMPARATIVE EVOLUTION OF BEQUEST TAXATION IN HISTORICAL PERSPECTIVE

Bequest tax revenues have been declining in OECD countries for at least 70 years. We propose an explanation that is based on a dynamic politico‐economic model where the evolution of bequest taxation is determined by wealth inequality. Since economic development induces a growing role of labor income and thus a reduction of wealth inequality, bequest taxation is reduced over time. The model also embeds a process of structural reallocation from agriculture to manufacturing and a consequent shift of the tax base from easy‐to‐tax land to hard‐to‐tax capital. This process implies a lower tax level and slower equalization‐induced tax reduction, the higher is the tax avoidance rate and the less developed is the economy. The introduction of franchise restrictions which are gradually lifted over time allows the hump‐shaped long‐term evolution of bequest taxation to be reproduced starting from the nineteenth century for those countries that are now modern industrial democracies. The evolution of political institutions also helps to explain the discrepancies currently observed between tax systems in developed and underdeveloped countries.     

Annuities, Bequests, and Portfolio Diversification

In this article, the diversification motives of the demand for annuities is analyzed. Using a model allowing for the uncertainty of both the human life length and the interest rate, the Decision Maker is supposed to choose an optimal portfolio to maximize a bequest. Conditions under which an increase in the risk of bond returns increase the demand for annuities are proposed and discussed. Moreover, it is shown that, contrary to previous claims, more risk adversion is associated with a lower demand for annuities.     

Accidental Bequests: A Curse for the Rich and a Boon for the Poor*

When accidental bequests signal otherwise unobservable individual characteristics, such as productivity and longevity, the population should be partitioned into two groups: those who do not receive an inheritance and those who do. The first tagged group receives a Mirrlees second‐best tax schedule; the second group, when its type is fully revealed, faces a first‐best tax schedule. Receiving an inheritance makes high‐ability types worse off and low‐ability types better off. High‐ability individuals face a bequest tax of more than 100 percent, while low‐ability types face a bequest tax that can be smaller, as well as larger, than 100 percent, and it might even be negative.     

Taxation, Bequests, and Short and Long Run Timber Supplies: An Overlapping Generations Problem

This paper uses an overlapping generations model with one-sided altruism to study the effects of several forest taxes that target bequests and affect timber supply. Unlike previous work, we investigate bequests and timber supply in both the short and long run when bequests are costly (e.g., taxed). The landowner's problem is examined in the short run, while the government's problem is examined in the long run assuming the existence of a steady state. We also consider taxes targeting harvests, growth, savings and bequests. Several new results are established concerning the interactions of taxes that might be used by a government to alter short and long run forest capital stocks: (i) the presence of a forest bequest tax affects the neutrality of harvest tax in both the short and long run, (ii) in the long run the bequest tax decreases bequests and timber supplies. When the bequest tax is not present, the capital income tax is neutral with respect to bequest and timber supply, while the harvest tax is neutral only if forest productivity is also not taxed. Finally, (iii) in the short run, the substitution and total effects of taxes in landowner decisions generally depend on the presence of the bequest tax. The results have implications for Pigouvian tax design and second best tax choice.     

Home equity commitment and long-term care insurance demand

This paper shows how home equity may substitute for long-term care insurance (LTCI). The elderly commonly hold substantial wealth in the form of home equity that is rarely spent before death, except for after moves to long-term care facilities. Absent strong bequest motives implies that marginal utility fluctuates less across health states than one would predict based on a standard model without wealth tied up in housing. Numerical examples show that this “asset commitment” may substantially weaken LTCI demand.     

Estate recovery and long‐term care insurance

Estate recovery is a policy under which the state recovers part of long‐term care (LTC) subsidies from the estates of deceased beneficiaries. This paper studies the effect of estate recovery on LTC insurance demand. This effect strongly relies on the bequest motive since the main purpose behind purchasing LTC insurance is to protect bequests from the financial costs of LTC. We find that the impact of estate recovery on LTC insurance depends on the level of parental bequests and on whether and how the parent anticipates the child's preferences with respect to informal care. More specifically, we show that estate recovery encourages the parent to purchase LTC insurance when his child is considered selfish or to like providing care. However, this policy could provide disincentives to LTC insurance purchase by the parent if his child is considered to dislike providing informal care. Our results also show that estate recovery reduces and may even eliminate public support crowding out of private LTC insurance demand. Finally, we characterize the welfare implications of financing LTC public support by estate recovery.     

Capital Income Taxation,Economic Growth and Heterogeneity in the Motivation to Give

This study provides a comprehensive analysis of the relationship between capital income taxation and economic growth within an overlapping generations model when individuals may bequeath wealth. The altruistic concern is modeled as a synthesis of joy‐of‐giving and family altruism so that individuals may derive utility from the amount of bequest itself and by providing children with a disposable income later on in life. Using this framework, it is shown that, in contrast to the existing literature, increasing the capital income tax rate may well enhance growth under operative bequests.     

Optimal Taxation of Risky Human Capital*

In a two‐period life‐cycle model with ex ante homogeneous households, earnings risk, and a general earnings function, we derive the optimal linear labor tax rate and optimal linear education subsidies. The optimal income tax trades off social insurance against incentives to work. Education subsidies are not used for social insurance, but they are only targeted at offsetting the distortions of the labor tax and internalizing a fiscal externality. Both optimal education subsidies and tax rates increase if labor and education are more complementary, because education subsidies indirectly lower labor tax distortions by stimulating labor supply. Optimal education subsidies (taxes) also correct non‐tax distortions arising from missing insurance markets. Education subsidies internalize a positive (negative) fiscal externality if there is underinvestment (overinvestment) in education because of risk. Education policy unambiguously allows for more social insurance if education is a risky activity. However, if education hedges against labor‐market risk, optimal tax rates could be lower than in the case without education subsidies.     

On the value of Medicaid in providing access to long‐term care

The crowding‐out by Medicaid has been identified as a possible reason for the low demand for private long‐term care (LTC) insurance in the USA. I extend the previous analysis to the case in which budget constraints inhibit access to care. This reduces the role of the implicit tax and fundamentally changes the nature, scope, and welfare implications of crowding‐out. It suggests a large value of Medicaid that a private insurance market is unable to offer due to a dilemma prevalent in—but not exclusive to—the market for LTC insurance: a dilemma between access and affordability.     

Estate taxes, consumption externalities, and altruism

We study how the introduction of consumption externalities affects the optimality of the dynamic equilibrium in an economy displaying dynastic altruism. When the bequest motive is inoperative consumption externalities affect the intertemporal margin between young and old consumption and thus modify the intertemporal path of aggregate consumption and capital. The optimal tax policy that solves this intertemporal suboptimality consists of a tax on capital income and a pay-as-you-go social security system. The latter solves the excess of capital accumulation due to the inoperativeness of the bequest motive and the former solves the suboptimal allocation of consumption due to consumption externalities. When the bequest motive is operative consumption externalities only cause an intratemporal misallocation of consumption but do not affect the optimality of the capital stock level. This suboptimal allocation of consumption implies in turn that the path of bequest deviates also from optimality. The optimal tax policy in this case consists of an estate tax and a capital income tax.     

The consumption tax in the presence of altruistic cash and human capital bequests with endogenous fertility decisions

We provide an analysis of the consumption tax policy in the presence of cash bequests, human capital investments in children, and endogenous fertility decisions. It is shown that the consumption tax is no longer neutral if the tax rate is constant over the taxpayer's life cycle, labor supply is exogenous, and the parent expects the offspring to pay the same tax rate, if the number of children is chosen optimally by the parent. Neutrality breaks down because the shadow prices of both bequests and fertility are interlinked; it is more expensive to produce a child the larger either bequest is and it is more expensive to make a bequest of either type to each child the larger the number of children produced. Several examples are provided where imposing the consumption tax induces an increase in the number of children produced and a decrease in net capital formation.     

Age-related taxation of bequests in the presence of a dependency risk

This paper studies the properties of the optimal taxes on bequests when individuals differ in wage and in their risks of mortality and old-age dependance. Survival is positively correlated to income but dependency is negatively correlated with it. The government cannot distinguish between bequests motives, that is whether bequests resulted from precautionary reasons or from pure joy of giving reasons. Instead, it observes the timing of bequests and the health status at death. Under the utilitarian social welfare criterion, we show that bequests taxation results from a combination of equity, insurance, and public revenue motives. If redistribution concerns dominate insurance concerns, it is desirable to tax the most bequests of those individuals living long in good health and to tax the least bequests of those dying early. This is a direct consequence of the socio-demographic structure we assumed where richer agents live longer and in better health than poorer agents. To the opposite, if insurance concerns dominate redistributive concerns, early bequests should be the most taxed and, bequests under dependency the least taxed. Under the Rawlsian criterion, we find that early bequests should be the least taxed and bequests left by the healthy long-lived individuals should be the most taxed.     

CONSUMPTION RESPONSE TO GOVERNMENT TRANSFERS: BEHAVIORAL MOTIVES REVEALED BY SAVERS AND SPENDERS

This article surveyed recipients of one‐off government transfers in Singapore to investigate to what extent different behavioral motives might have affected their consumption response. It also investigates how the recipients' personal characteristics might have affected their consumption response and the appeal of different motives. In the sample surveyed, savers were mostly motivated by precautionary saving, followed by Ricardian equivalence, whereas spenders were mainly driven by rule of thumb and present bias. The bequest motive turned out to be unimportant. Older, better educated, and economically better‐off individuals facing no liquidity constraint were more likely to be savers. (JEL D91, E21, E62, H31)     

THE RISK‐FREE RATE IN A FINITE HORIZON MODEL WITH BEQUESTS

This paper studies the risk‐free rate in an overlapping generations economy with bequests. It is shown that the risk‐free rate depends on risk aversion, the elasticity of intertemporal substitution, the share of wealth invested in human wealth, life expectancy, and the preference for bequests. In a standard life‐cycle context, mortality increases the subjective time rate of discount, and thus increases the compensation required to postpone consumption. This latter effect is offset in a bequest‐driven model of the type considered here, leading to much more powerful income effects. In this sense, the model provides a bequest‐motive explanation for the risk‐free rate puzzle put forward by Weil in 1989.     

Tax subsidies,the rational demand for insurance and the health care crisis

An individual's optimal insurance coverage depends on balancing his gain through avoiding risk against his loss through the distortion of demand. The U.S. tax system subsidizes the purchase of excessive health insurance by excluding employer premium payments from employees' taxable incomes and by permitting the deduction of a portion of individual premiums. The current operational model of demand for health insurance shows that the tax subsidy does substantially increase insurance coverage. Since much of the rise in health care costs can be attributed to the growth of insurance, the tax subsidy is responsible for much of what is widely perceived as a health care crisis.     

Tax incentives and the decision to purchase long-term care insurance

This paper studies the impact of the tax incentive prescribed in the Health Insurance Portability and Accountability Act of 1996 (HIPAA) on individuals' long-term care insurance purchasing behavior. Using data from the Health and Retirement Study, we find that the tax incentive in HIPAA increased the take-up rate of private LTC insurance by 3.3 percentage points, or 25%, for those eligible. Despite this seemingly strong response, our results imply that even an above-the-line tax deduction would not increase the coverage rate of seniors beyond 13%, indicating that tax incentives alone are unlikely to expand the market substantially. We also present, to our knowledge, the first estimate of the price elasticity of demand for LTC insurance of around ? 3.9, suggesting that demand is highly elastic at the current low ownership rate. Finally, we evaluate the net fiscal impact of the tax incentive and find that the tax deductibility of LTC insurance premiums leads to a net revenue loss for the government, as the reduced tax revenue from granting the tax incentive exceeds the savings in Medicaid's LTC expenditures.