solution

Inheritance taxes are older than income taxes. Caesar Augustus instituted a 5% tax on all inheritances (except gifts to children and spouses) to provide retirement funds for the military. During the George W. Bush administration, congressional Republicans and Democrats vociferously debated the wisdom of cutting income taxes and inheritance taxes (which the Republicans call the “death tax”) to stimulate the economy by inducing people to work harder. Presumably the government cares about a tax’s effect on work effort and tax revenues.

a. Suppose George views leisure as a normal good. He works at a job that pays w an hour. Use a labor-leisure analysis to compare the effects on the hours he works from a marginal tax rate on his wage, or a lump-sum tax (a tax collected regardless of the number of hours he works), T. If the per-hour tax is used, he works 10 hours and earns 10w (1 – Ï„). The government sets T = 10wÏ„ so that it earns the same from either tax.

b. Now suppose that the government wants to raise a given amount of revenue through taxation with either an inheritance tax or an income (wage) tax. Which is likely to reduce George’s hours of work more, and why?