Fair optimal tax with endogenous productivities

We consider a model where agents differ in their preferences about consumption, labor, and human capital. Moreover, choosing a certain level of human capital, agents can differently affect their endogenous earning ability. Finally, agents differ in their human capital disposition: different agents face a different cost to acquire a certain amount of human capital. In this framework we study the problem of assessing tax reforms when a policy maker wants to reduce inequalities due to unequal skills while accepting inequalities due to diverse preferences. Consistent with the findings of the fair income taxation literature, when evaluating a tax reform, in order to obtain a social improvement one should always give priority to agents with the most disadvantaged characteristics who work full time. However, in our framework, this corresponds to a whole range of earnings depending on the corresponding level of human capital. We show how subsidies on human capital affect the level of earnings that gets most priority in order to single out more precisely the population that should be the focus of the reform. Relying on these findings we also study the shape of the optimal tax function.