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Optimal Taxation of Risky Human Capital

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  • Bas Jacobs
  • Dirk Schindler
  • Hongyan Yang

Abstract

In a model with ex-ante homogenous 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 and to invest in human capital. Education subsidies are not used for social insurance, but are only targeted at off-setting 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, since 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 due to 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 without education subsidies.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 2529.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2529

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Keywords: labor taxation; human capital investment; education subsidies; idiosyncratic risk; risk properties of human capital;

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References

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  1. Diamond, Peter A & Mirrlees, James A, 1986. " Payroll-Tax Financed Social Insurance with Variable Retirement," Scandinavian Journal of Economics, Wiley Blackwell, vol. 88(1), pages 25-50.
  2. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Oxford University Press, vol. 70(3), pages 569-587.
  3. Hartog,Joop & Maassen van den Brink,Henriëtte (ed.), 2007. "Human Capital," Cambridge Books, Cambridge University Press, number 9780521873161, October.
  4. Cremer, Helmuth & Gahvari, Firouz, 1995. "Uncertainty, Optimal Taxation and the Direct versus Indirect Tax Controversy," Economic Journal, Royal Economic Society, vol. 105(432), pages 1165-79, September.
  5. Bas Jacobs & A. Bovenberg, 2010. "Human capital and optimal positive taxation of capital income," International Tax and Public Finance, Springer, vol. 17(5), pages 451-478, October.
  6. Bovenberg, A Lans & Jacobs, Bas, 2001. "Redistribution and Education Subsidies are Siamese Twins," CEPR Discussion Papers 3099, C.E.P.R. Discussion Papers.
  7. P. A. Diamond & J. A. Mirrlees, 1977. "A Model of Social Insurance With Variable Retirement," Working papers 210, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Dan Anderberg, 2008. "Optimal Policy and the Risk Properties of Human Capital Reconsidered," CESifo Working Paper Series 2451, CESifo Group Munich.
  9. Christian Belzil & Jörgen Hansen, 2004. "Earnings Dispersion, Risk Aversion and Education," Post-Print halshs-00180125, HAL.
  10. Hans-Werner Sinn, 1996. "Social insurance, incentives and risk taking," International Tax and Public Finance, Springer, vol. 3(3), pages 259-280, July.
  11. Costa, Carlos Eugênio da & Maestri, Lucas Jóver, 2004. "The risk-properties of human capital and the design of government policies," Economics Working Papers (Ensaios Economicos da EPGE) 554, FGV/EPGE Escola Brasileira de Economia e Finanças, Getulio Vargas Foundation (Brazil).
  12. Feldstein, Martin S, 1972. "Distributional Equity and the Optimal Structure of Public Prices," American Economic Review, American Economic Association, vol. 62(1), pages 32-36, March.
  13. Mikhail Golosov & Aleh Tsyvinski & Ivan Werning, 2007. "New Dynamic Public Finance: A User's Guide," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 317-388 National Bureau of Economic Research, Inc.
  14. Varian, Hal R., 1980. "Redistributive taxation as social insurance," Journal of Public Economics, Elsevier, vol. 14(1), pages 49-68, August.
  15. Louis Kaplow, 1991. "Taxation and Risk Taking: A General Equilibrium Perspective," NBER Working Papers 3709, National Bureau of Economic Research, Inc.
  16. Levhari, David & Weiss, Yoram, 1974. "The Effect of Risk on the Investment in Human Capital," American Economic Review, American Economic Association, vol. 64(6), pages 950-63, December.
  17. Bas Jacobs, 2005. "Optimal Income Taxation with Endogenous Human Capital," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 7(2), pages 295-315, 05.
  18. International Monetary Fund, 1999. "Risk, Resources, and Education," IMF Working Papers 99/174, International Monetary Fund.
  19. Ignacio Palacios-Huerta, 2003. "An Empirical Analysis of the Risk Properties of Human Capital Returns," American Economic Review, American Economic Association, vol. 93(3), pages 948-964, June.
  20. Grochulski, Borys & Piskorski, Tomasz, 2010. "Risky human capital and deferred capital income taxation," Journal of Economic Theory, Elsevier, vol. 145(3), pages 908-943, May.
  21. Bas Jacobs & Lans Bovenberg, 2008. "Optimal Taxation of Human Capital and theEarnings Function," CESifo Working Paper Series 2250, CESifo Group Munich.
  22. Cremer, Helmuth & Gahvari, Firouz, 1995. "Uncertainty and optimal taxation: In defense of commodity taxes," Journal of Public Economics, Elsevier, vol. 56(2), pages 291-310, February.
  23. Kaplow, Louis, 1994. "Taxation and Risk Taking: A General Equilibrium Perspective," National Tax Journal, National Tax Association, vol. 47(4), pages 789-98, December.
  24. Eaton, Jonathan & Rosen, Harvey S., 1980. "Labor supply, uncertainty, and efficient taxation," Journal of Public Economics, Elsevier, vol. 14(3), pages 365-374, December.
  25. Hamilton, Jonathan H, 1987. "Optimal Wage and Income Taxation with Wage Uncertainty," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(2), pages 373-88, June.
  26. Anderberg, Dan & Andersson, Fredrik, 2003. "Investments in human capital, wage uncertainty, and public policy," Journal of Public Economics, Elsevier, vol. 87(7-8), pages 1521-1537, August.
  27. repec:dgr:uvatin:2005035 is not listed on IDEAS
  28. Gould, Eric D & Moav, Omer & Weinberg, Bruce A, 2001. " Precautionary Demand for Education, Inequality, and Technological Progress," Journal of Economic Growth, Springer, vol. 6(4), pages 285-315, December.
  29. repec:dgr:uvatin:2005036 is not listed on IDEAS
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Citations

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Cited by:
  1. Dan Anderberg, 2009. "Optimal Policy and the Risk-Properties of Human Capital Reconsidered," 2009 Meeting Papers 166, Society for Economic Dynamics.
  2. Robin Boadway & Motohiro Sato, 2011. "Optimal Income Taxation with Uncertain Earnings: A Synthesis," CESifo Working Paper Series 3654, CESifo Group Munich.
  3. Mendolicchio, Concetta & Paolini, Dimitri & Pietra, Tito, 2012. "Asymmetric information and overeducation," IAB Discussion Paper 201214, Institut für Arbeitsmarkt- und Berufsforschung (IAB), Nürnberg [Institute for Employment Research, Nuremberg, Germany].
  4. Bas Jacobs & Hongyan Yang, 2013. "Second-Best Income Taxation with Endogenous Human Capital and Borrowing Constraints," CESifo Working Paper Series 4155, CESifo Group Munich.
  5. Mendolicchio, Concetta & Paolini, Dimitri & Pietra, Tito, 2011. "Income taxes, subsidies to education, and investments in human capital," IAB Discussion Paper 201107, Institut für Arbeitsmarkt- und Berufsforschung (IAB), Nürnberg [Institute for Employment Research, Nuremberg, Germany].
  6. Sebastian Findeisen & Dominik Sachs, 2011. "Education and optimal dynamic taxation: The role of income-contingent student loans," ECON - Working Papers 040, Department of Economics - University of Zurich, revised Sep 2012.
  7. Findeisen, Sebastian & Sachs, Dominik, 2011. "Education and Optimal Dynamic Taxation," IZA Discussion Papers 6056, Institute for the Study of Labor (IZA).

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