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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 wedges and wealth taxes in a Mirrleesian economy with endogenous skills. Human capital is a private state variable that drives the skill process of each individual. Building on the findings of the labor literature, we assume that human capital investment is a) risky, b), done early in the life-cycle, and c) indistinguishable from consumption. These assumptions lead to the optimality of a) a human capital premium, i.e., an excess return on human capital relative to physical capital, b) a large intertemporal wedge early in the life-cycle stemming from the lack of Rogerson's (1985) "inverse Euler" characterization of the optimal consumption process, and c) an intra-temporal distortion of the effort/consumption margin even at the top of the skill distribution at all dates except of the terminal date. The main implication for the structure of linear wealth taxes is the necessity of deferred taxation of wealth. In particular, deferred taxation of wealth prevents the agents from making a joint deviation of under-investing in human capital ex ante and shirking at some future date in the life-cycle, as the marginal differed tax rate on wealth held early in the life-cycle is history-dependent. Also, the present value of aggregate marginal tax rate is zero at all dates, which means that, as in Kocherlakota (2005), the government revenue from wealth taxation is zero. Relative to economies with exogenous skills, the optimal marginal wealth tax rate is more volatile

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 59.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:59

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Keywords: Optimal taxation; human capital; Mirrlees approach.;

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References

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  1. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 1-30.
  2. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2002. "Optimal Indirect and Capital Taxation," Levine's Working Paper Archive 391749000000000449, David K. Levine.
  3. 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.
  4. Jones, Larry E. & Manuelli, Rodolfo E. & Rossi, Peter E., 1997. "On the Optimal Taxation of Capital Income," Journal of Economic Theory, Elsevier, vol. 73(1), pages 93-117, March.
  5. Michele Boldrin & Ana Montes, 2004. "The intergenerational state: education and pensions," Staff Report 336, Federal Reserve Bank of Minneapolis.
  6. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
  7. Stefania Albanesi, 2007. "Optimal taxation of entrepreneurial capital with private information," Discussion Papers 0607-11, Columbia University, Department of Economics.
  8. Narayana Kocherlakota, 2004. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Levine's Bibliography 122247000000000729, UCLA Department of Economics.
  9. Ignacio Palacios-Huerta, 2001. "An Empirical Analysis of the Risk Properties of Human Capital Returns," Working Papers 2001-10, Brown University, Department of Economics.
  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. 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.
  12. Narayana R. Kocherlakota, 2004. "Wedges and Taxes," American Economic Review, American Economic Association, vol. 94(2), pages 109-113, May.
  13. Emmanuel Farhi & Ivan Werning, 2006. "Progressive Estate Taxation," NBER Working Papers 12600, National Bureau of Economic Research, Inc.
  14. Narayana R Kocherlakota, 2005. "Advances in Dynamic Optimal Taxation," Levine's Bibliography 784828000000000518, UCLA Department of Economics.
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Cited by:
  1. 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.
  2. Marek Kapicka & Radim Bohacek, 2007. "Optimal Human Capital Policies," 2007 Meeting Papers 464, Society for Economic Dynamics.
  3. Stefania Albanesi, 2006. "Optimal Taxation of Entrepreneurial Capital with Private Information," NBER Working Papers 12419, National Bureau of Economic Research, Inc.
  4. 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.

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