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Optimal Taxation with Risky Human Capital

Author

Listed:
  • Marek Kapicka

    (U.C. Santa Barbara and CERGE-EI)

  • Julian Neira

    (Department of Economics, University of Exeter)

Abstract

We study optimal tax policies in a life-cycle economy with risky human capital and permanent ability differences, where both ability and learning effort are private information of the agents. The optimal policies balance several goals: redistribution across agents, insurance against human capital shocks, incentives to accumulate human capital, and incentives to work. We show that, in the optimum, i) high-ability agents face risky consumption in order to elicit learning effort while low-ability agents are insured, ii) high-ability agents face a higher savings tax to discourage them from self-insuring, iii) under certain conditions, the inverse marginal labor income tax rate follows a random walk, and iv) the “no distortion at the top” result does not apply if discouraging labor supply increases incentives to invest in human capital. Quantitatively, we find large welfare gains for the U.S. from switching to an optimal tax system.

Suggested Citation

  • Marek Kapicka & Julian Neira, 2015. "Optimal Taxation with Risky Human Capital," Discussion Papers 1504, University of Exeter, Department of Economics.
  • Handle: RePEc:exe:wpaper:1504
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    File URL: http://people.exeter.ac.uk/RePEc/dpapers/DP1504.pdf
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    References listed on IDEAS

    as
    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. Sebastian Koehne & Nicola Pavoni & Arpad Abraham, 2011. "Optimal Income Taxation with Asset Accumulation," 2011 Meeting Papers 1161, Society for Economic Dynamics.
    3. Ivan Werning & Emmanuel Farhi, 2005. "Inequality, Social Discounting and Estate Taxation," 2005 Meeting Papers 358, Society for Economic Dynamics.
    4. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 1-30.
    5. 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.
    6. repec:mea:meawpa:13267 is not listed on IDEAS
    7. Stiglitz, Joseph E., 1982. "Self-selection and Pareto efficient taxation," Journal of Public Economics, Elsevier, vol. 17(2), pages 213-240, March.
    Full references (including those not matched with items on IDEAS)

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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. Findeisen, Sebastian & Sachs, Dominik, 2017. "Redistribution and insurance with simple tax instruments," Journal of Public Economics, Elsevier, vol. 146(C), pages 58-78.
    3. Findeisen, Sebastian & Sachs, Dominik, 2015. "Designing efficient college and tax policies," Working Papers 15-09, University of Mannheim, Department of Economics.
    4. 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.
    5. 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.
    6. 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.
    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.

    More about this item

    Keywords

    optimal taxation; income taxation; human capital;

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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