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Optimal Taxation with Risky Human Capital

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  • Marek Kapička
  • Julian Neira

Abstract

We study optimal tax policies in a life-cycle economy with permanent ability differences and risky human capital investments that have both an unobservable component, learning effort, and an observable component, schooling. The optimal policies balance redistribution across agents, insurance against human capital shocks, and incentives to learn and work. In the optimum, (i) high-ability agents face risky consumption while low-ability agents are insured; (ii) the optimal schooling subsidy is substantial but less than 100 percent; (iii) if utility is separable in labor and learning effort, the inverse labor wedge follows a random walk; and (iv) if the utility is not separable then the "no distortion at the top" result does not apply. The welfare gains from switching to the optimal tax system are about 1 percent in annual consumption equivalents.

Suggested Citation

  • Marek Kapička & Julian Neira, 2019. "Optimal Taxation with Risky Human Capital," American Economic Journal: Macroeconomics, American Economic Association, vol. 11(4), pages 271-309, October.
  • Handle: RePEc:aea:aejmac:v:11:y:2019:i:4:p:271-309
    Note: DOI: 10.1257/mac.20160365
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    References listed on IDEAS

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    1. Battaglini, Marco & Coate, Stephen, 2008. "Pareto efficient income taxation with stochastic abilities," Journal of Public Economics, Elsevier, vol. 92(3-4), pages 844-868, April.
    2. Árpád Ábrahám & Sebastian Koehne & Nicola Pavoni, 2014. "Optimal Income Taxation with Asset Accumulation," CESifo Working Paper Series 5138, CESifo Group Munich.
    3. Alexander Ludwig & Dirk Krueger, 2010. "Optimal Progressive Taxation and Education Subsidies in a Model of Endogenous Human Capital Formation," 2010 Meeting Papers 388, Society for Economic Dynamics.
    4. Ivan Werning & Emmanuel Farhi, 2005. "Inequality, Social Discounting and Estate Taxation," 2005 Meeting Papers 358, Society for Economic Dynamics.
    5. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 1-30.
    6. Sebastian Koehne & Nicola Pavoni & Arpad Abraham, 2011. "Optimal Income Taxation with Asset Accumulation," 2011 Meeting Papers 1161, Society for Economic Dynamics.
    7. Stiglitz, Joseph E., 1982. "Self-selection and Pareto efficient taxation," Journal of Public Economics, Elsevier, vol. 17(2), pages 213-240, March.
    8. repec:mea:meawpa:13267 is not listed on IDEAS
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    Citations

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    Cited by:

    1. Dominik Sachs & Sebastian Findeisen, 2016. "Optimal Financial Aid Policies for Students," 2016 Meeting Papers 1421, Society for Economic Dynamics.
    2. Sebastian Findeisen & Dominik Sachs, 2015. "Redistribution and Insurance with Simple Tax Instruments," CESifo Working Paper Series 5400, CESifo Group Munich.
    3. Sebastian Findeisen & Dominik Sachs, 2015. "Designing Efficient College and Tax Policies," CESifo Working Paper Series 5435, CESifo Group Munich.
    4. Findeisen, Sebastian & Sachs, Dominik, 2017. "Redistribution and insurance with simple tax instruments," Journal of Public Economics, Elsevier, vol. 146(C), pages 58-78.
    5. Ábrahám, Árpád & Koehne, Sebastian & Pavoni, Nicola, 2016. "Optimal income taxation when asset taxation is limited," Journal of Public Economics, Elsevier, vol. 136(C), pages 14-29.
    6. Findeisen, Sebastian & Sachs, Dominik, 2016. "Education and optimal dynamic taxation: The role of income-contingent student loans," Journal of Public Economics, Elsevier, vol. 138(C), pages 1-21.
    7. Suehuyn Kwon, 2017. "Mechanism Design with Moral Hazard," CESifo Working Paper Series 6621, CESifo Group Munich.
    8. OBARA, Takuya, 2018. "Optimal human capital policies under the endogenous choice of educational types," CCES Discussion Paper Series 66_v2, Center for Research on Contemporary Economic Systems, Graduate School of Economics, Hitotsubashi University.
    9. Koeniger, Winfried & Zanella, Carlo, 2020. "Opportunity and Inequality across Generations," Economics Working Paper Series 2003, University of St. Gallen, School of Economics and Political Science.
    10. OBARA, Takuya, 2017. "Optimal human capital policies under the endogenous choice of educational types," CCES Discussion Paper Series 66, Center for Research on Contemporary Economic Systems, Graduate School of Economics, Hitotsubashi University.

    More about this item

    JEL classification:

    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • I26 - Health, Education, and Welfare - - Education - - - Returns to Education
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity

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