Equalizing Outcomes and Equalizing Opportunities: Optimal Taxation when Children’s Abilities Depend on Parents’ Resources

Empirical research suggests that parents’economic resources affect their children’s future earnings abilities. Optimal tax policy therefore treats future ability distributions as endogenous to current taxes. We model this endogeneity, calibrate the model to match estimates of the intergenerational transmission of earnings ability in the United States, and use the model to simulate such an optimal policy numerically. The optimal policy in this context is more redistributive toward low-income parents than existing U.S. tax policy. It also increases the probability that low-income children move up the economic ladder, generating a present-value welfare gain of one and three-quarters percent of consumption in our baseline case. ∗Gelber: UC Berkeley and NBER, [email protected]; Weinzierl: Harvard Business School and NBER, [email protected]. We thank participants at the Cowles Summer Conference on Advances in Dynamic Taxation, the National Tax Association annual meeting, and seminars at IFS/LSE, Harvard, Hebrew University, the University of Pennsylvania, and Stanford. We thank Jillian Popadak, Jerry Yeh, and Roger Ou for research assistance and Benjamin B. Lockwood for exceptional work on the computational simulations. We thank the Entrepreneurship and Family Business Research Centre, Center for Human Resources, Mack Center, Zicklin Center, Risk and Decision Processes Center, and Global Initiatives Center, all at Wharton, for generous research support. We would especially like to thank Doug Bernheim, Caroline Hoxby, Marek Kapicka, Robert E. Lucas, Luigi Pistaferri, Monica Singhal, Michele Tertilt, Aleh Tsyvinski, and several anonymous referees for comments and suggestions. We thank Gordon Dahl, Lance Lochner, Dave Rapson, and Larry Kotlikoff for sharing data.