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a blog from young economists at Nova SBE

To Gift or to Bequest?

One major fact to bear in mind when estimating the effects of introducing a certain tax is the possibility that agents might change their behaviour due to that same tax. Agents often react to taxes by reducing the quantity consumed of that good or by simply switching to another good. Hence, taxes, as well as deductions, in certain circumstances, can be seen as an instrument to achieve certain behaviour.
We can apply this analysis to intergenerational transfers, which are called gifts between the living (the legal term is “inter-vivos” gifts), or bequests, when these transfers take place at death. Hence, in our simple model we are considering an individual who is choosing between two options on how to use his money – gifts and bequests. Many factors influence the way people allocate transfers between these modalities, and one particular factor that is relevant in our discussion is the way taxes and deductions are split between them and thus changing its respective relative prices (if we think of a 2 good choice model).
A gift tax is a tax on the transfer of property by one individual to another while receiving nothing, or less than full value, in return, while the estate tax, on the other hand, falls on the value of one’s wealth, at the date of death. There are several ways to reduce the taxable estate, and one of them is through charitable deductions – the amount given as charity is deductible from the taxable estate. Thus this deduction gives a strong incentive to charity giving through bequests. (1)
In fact, Jon Bakija, William Gale and Joel Slemrod (2003)(2), tried to identify some relation between the existence of taxes and the amount of charitable bequests, which, as said before, are exempt from taxation. They stated that abolishing the 49% top marginal rate of federal estate tax (2003) would approximately double the price of a charitable bequest relative to an ordinary bequest for the wealthiest estates, leading to a possible reduction of the charitable bequests. In other words, the price elasticity of charitable bequests is large and significant, which means that increasing the (relative) price of this modality will lead to a large reduction on charitable bequests.
David Joulfaian (2005)(3), on the other hand, tried to establish a link between capital gains, gift and estate taxes and the allocation of transfers between lifetime gifts and bequests by the more wealthy. The author demonstrated that capital gains taxes and gift taxes significantly discourage lifetime gifts. Furthermore, he found that taxes play a significant role on the timing of the transfers, even for the wealthiest.
In the US, estate tax was subject to several reforms in the past decade – the 2001 Tax Act increased the applicable exclusion amount (for gift tax purposes) which progressively increased until 2009. In 2010, the Tax Relief Act reunified the estate and gift tax exclusions at $5 million (indexed for inflation), and the American Taxpayer Relief Act of 2012 made the higher exemption amount permanent while increasing the estate and gift tax rate to 40%. Because of inflation, the estate and gift tax exemption is $5.34 million in 2014. The lifetime gift and the estate tax exclusion are expressed as a total amount – currently $5.34 million per person – and if you exceed the limit, you (or your heirs) will owe tax of up to 40%. (4)
How these reforms affect the amount of estate given to charity and the way people allocate their transfers is still unknown and merit of future study.

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David Dias Pissarra.


Author: studentnovasbe

Master student in Nova Sbe

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