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Optimal wealth taxes with risky human capital

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  • Borys Grochulski
  • Tomasz Piskorski

Abstract

We study the structure of optimal wealth and labor income taxes in a Mirrlees economy in which the productivity of labor (i.e., skill) is private, stochastic, and endogenous. Individual agents' skills are determined by their level of human capital. Human capital is not publicly observable and the returns to human capital investment are subject to idiosyncratic shocks. Preferences are not assumed to be additively separable in consumption and human capital investment and, thus, the intertemporal marginal rates of substitution of consumption are private information. We characterize the optimal allocation and a tax system that implements this allocation in equilibrium. The optimal allocation does not satisfy the "reciprocal Euler equation" of Rogerson [Econometrica, 1985], which holds in Mirrlees economies with exogenous skills. The tax system we use in our decentralization of the optimum consists of a wealth tax that is linear in wealth and a labor income tax that depends solely on labor income. The result of Kocherlakota [Econometrica, 2005], establishing the optimality of zero expected marginal wealth tax rate, holds in our model. We show that endogenous skill determination affects the volatility of marginal wealth taxes rather than their expectation. Relative to economies with exogenous skills, the optimal marginal wealth tax rate is more volatile in our endogenous skill economy. Also, we demonstrate the optimality of a wedge in the returns on the two assets present in our economy: At the optimum, the marginal return on human capital investment is strictly larger than the marginal return on physical capital investment.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 05-13.

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Date of creation: 2005
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Handle: RePEc:fip:fedrwp:05-13

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Keywords: Human capital ; Wealth;

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  1. Boldrin, Michele & Montes, Ana, 2002. "The Intergenerational State: Education and Pensions," CEPR Discussion Papers 3275, C.E.P.R. Discussion Papers.
  2. Mikhail Golosov & Narayana R. Kocherlakota & Aleh Tsyvinski, 2001. "Optimal indirect and capital taxation," Working Papers 615, Federal Reserve Bank of Minneapolis.
  3. Albanesi, Stefania & Sleet, Christopher, 2003. "Dynamic Optimal Taxation with Private Information," CEPR Discussion Papers 4006, C.E.P.R. Discussion Papers.
  4. Larry E. Jones & Rodolfo E. Manuelli & Peter E. Rossi, 1993. "On the Optimal Taxation of Capital Income," NBER Working Papers 4525, National Bureau of Economic Research, Inc.
  5. Emmanuel Farhi & Ivan Werning, 2006. "Progressive Estate Taxation," NBER Working Papers 12600, National Bureau of Economic Research, Inc.
  6. 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.
  7. Narayana Kocherlakota, 2004. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Levine's Bibliography 122247000000000729, UCLA Department of Economics.
  8. Stefania Albanesi, 2006. "Optimal Taxation of Entrepreneurial Capital with Private Information," NBER Working Papers 12419, National Bureau of Economic Research, Inc.
  9. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
  10. Heckman, James J, 1976. "A Life-Cycle Model of Earnings, Learning, and Consumption," Journal of Political Economy, University of Chicago Press, vol. 84(4), pages S11-44, August.
  11. Narayana R. Kocherlakota, 2004. "Wedges and Taxes," American Economic Review, American Economic Association, vol. 94(2), pages 109-113, May.
  12. Narayana R Kocherlakota, 2005. "Advances in Dynamic Optimal Taxation," Levine's Bibliography 784828000000000518, UCLA Department of Economics.
  13. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
  14. Davies, James B. & Zeng, Jinli & Zhang, Jie, 2000. "Consumption vs. income taxes when private human capital investments are imperfectly observable," Journal of Public Economics, Elsevier, vol. 77(1), pages 1-28, July.
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Cited by:
  1. Bas Jacobs & A. Lans Bovenberg, 2005. "Human Capital and Optimal Positive Taxation of Capital Income," Tinbergen Institute Discussion Papers 05-035/3, Tinbergen Institute.
  2. da Costa, Carlos E. & Severo, Tiago, 2008. "Education, preferences for leisure and the optimal income tax schedule," Journal of Public Economics, Elsevier, vol. 92(1-2), pages 113-138, February.
  3. Stefania Albanesi, 2007. "Optimal taxation of entrepreneurial capital with private information," Discussion Papers 0607-11, Columbia University, Department of Economics.
  4. Marek Kapicka & Radim Bohacek, 2007. "Optimal Human Capital Policies," 2007 Meeting Papers 464, Society for Economic Dynamics.

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