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Optimal wealth taxes with risky human capital

Author

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  • Borys Grochulski
  • Tomasz Piskorski

Abstract

We study the structure of optimal wealth and labor income taxes in a Mirrlees economy in which the productivity of labor (i.e., skill) is private, stochastic, and endogenous. Individual agents' skills are determined by their level of human capital. Human capital is not publicly observable and the returns to human capital investment are subject to idiosyncratic shocks. Preferences are not assumed to be additively separable in consumption and human capital investment and, thus, the intertemporal marginal rates of substitution of consumption are private information. We characterize the optimal allocation and a tax system that implements this allocation in equilibrium. The optimal allocation does not satisfy the "reciprocal Euler equation" of Rogerson [Econometrica, 1985], which holds in Mirrlees economies with exogenous skills. The tax system we use in our decentralization of the optimum consists of a wealth tax that is linear in wealth and a labor income tax that depends solely on labor income. The result of Kocherlakota [Econometrica, 2005], establishing the optimality of zero expected marginal wealth tax rate, holds in our model. We show that endogenous skill determination affects the volatility of marginal wealth taxes rather than their expectation. Relative to economies with exogenous skills, the optimal marginal wealth tax rate is more volatile in our endogenous skill economy. Also, we demonstrate the optimality of a wedge in the returns on the two assets present in our economy: At the optimum, the marginal return on human capital investment is strictly larger than the marginal return on physical capital investment.

Suggested Citation

  • Borys Grochulski & Tomasz Piskorski, 2005. "Optimal wealth taxes with risky human capital," Working Paper 05-13, Federal Reserve Bank of Richmond.
  • Handle: RePEc:fip:fedrwp:05-13
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    References listed on IDEAS

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    1. Emmanuel Farhi & Iván Werning, 2010. "Progressive Estate Taxation," The Quarterly Journal of Economics, Oxford University Press, vol. 125(2), pages 635-673.
    2. 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.
    3. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 1-30.
    4. Michele Boldrin & Ana Montes, 2005. "The Intergenerational State Education and Pensions," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 651-664.
    5. Narayana R. Kocherlakota, 2005. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Econometrica, Econometric Society, vol. 73(5), pages 1587-1621, September.
    6. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Oxford University Press, vol. 70(3), pages 569-587.
    7. J. A. Mirrlees, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Oxford University Press, vol. 38(2), pages 175-208.
    8. 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 11-44, August.
    9. Narayana R. Kocherlakota, 2004. "Wedges and Taxes," American Economic Review, American Economic Association, vol. 94(2), pages 109-113, May.
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    12. 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.
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    Cited by:

    1. 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.
    2. Albanesi, Stefania, 2006. "Optimal Taxation of Entrepreneurial Capital with Private Information," CEPR Discussion Papers 5647, C.E.P.R. Discussion Papers.
    3. Bohacek, Radim & Kapicka, Marek, 2008. "Optimal human capital policies," Journal of Monetary Economics, Elsevier, vol. 55(1), pages 1-16, January.
    4. Bas Jacobs & A. Bovenberg, 2010. "Human capital and optimal positive taxation of capital income," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 17(5), pages 451-478, October.

    More about this item

    Keywords

    Human capital ; Wealth;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • J24 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Human Capital; Skills; Occupational Choice; Labor Productivity

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