Dynastic Precautionary Savings

August 29, 2017

By Corina Boar


This paper demonstrates that parents accumulate savings to insure their children against income risk. I refer to these as dynastic precautionary savings. Using a sample of matched parent-child pairs from the Panel Study of Income Dynamics, I test for dynastic precautionary savings by examining the response of parental consumption to the child’s permanent income uncertainty. I exploit variation in permanent income risk across age and industry-occupation groups to confirm that higher uncertainty in the child’s permanent income depresses parental consumption. In particular, I find that the elasticity of parental consumption to child’s permanent income risk ranges between -0.08 and -0.06, and is of similar magnitude to the elasticity of parental consumption to own income risk. Motivated by the empirical evidence, I analyze the implications of dynastic precautionary saving in a quantitative model of altruistically linked overlapping generations. I use the model to (i) examine the size and timing of inter-vivos transfers and bequest, (ii) perform counterfactual experiments to isolate the contribution of dynastic precautionary savings to wealth accumulation and intergenerational transfers, and (iii) assess the effect of two policy proposals that can affect parents’ incentives to engage in dynastic precautionary savings: universal basic income and guaranteed minimum income. Lastly, I explore the implications of strategic interactions between parents and children for parents’ precautionary and dynastic precautionary behavior.

This is a seriously cool paper. I can even relate to it on a personal level… With all the talk about increased uncertainty for the new generation, this is important work. It is also important to see what the implications are for mobility, because if only wealthy parents can give such a security blanket to their kids, a lot of untapped talent will remain unused. This is something we already worry about for access to education, and this paper shows that this is also important for the first years on the job market as well.


Quantifying the Welfare Gains from History Dependent Income Taxation

August 4, 2017

By Marek Kapicka


I quantify the welfare gains from introducing history dependent income tax in an incomplete markets framework where individuals face uninsurable random walk idiosyncratic shocks. I assume that the income tax paid is a function of a geometrical weighted average of past incomes, and solve for the optimal weights. I find that the optimal weights on past incomes decline geometrically at a rate equal to the discount rate. The welfare gains from history dependence are large, about 1.77 percent of consumption. I decompose the total effect into an efficiency effect that increases labor supply, and an insurance effect that reduces volatility of consumption and find that, quantitatively, the insurance effect dominates the efficiency effect. The optimal tax increases consumption insurance by trading higher tax progressivity with repect to past incomes for a reduced tax progressivity with respect to the current income.

Interesting result. It clearly makes sense that taxes should not only depend on income in the current snapshot in time. The paper shows that even a rigid formula on past taxes easily enhances welfare. Imagine if the formula were more flexible than a weighted average.