Pareto Efficient Taxation with Learning by Doing

I provide a general framework for analyzing the Pareto efficient income taxation in a Mirrlees economy with human capital formation. I show that human capital formation effectively makes preferences nonseparable over labor supply, and derive a tax formula that holds in any Pareto efficient allocation. I compare it with the optimal tax formula in a Ramsey economy, and show that both formulas differ because the Ramsey planner does not take into account intertemporal changes in the earnings distribution. Both learning-by-doing and learning-or-doing models are special cases of the general framework. I compare their implications for the efficient tax structure and show that in both models the optimal marginal tax rates decrease with age, despite the fact that both models respond differently to any given tax change. In the learning-by-doing model the result is driven by a decreasing contemporaneous labor elasticity, while in the learning-or-doing model the result is driven by the fact that labor supply is initially a substitute for future labor supply because it crowds out schooling.