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History-Dependent Individual Behavior, Polarization, and Pareto-Improving Activating Welfare

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  • Peter Funk

Abstract

This paper assumes that human capital not only generates market incomes but is a direct source of utility as well. In an otherwise standard framework it is shown that the interaction between human capital and effort in raising human capital and in generating utility naturally leads to history-dependent optimal individual behavior. Depending on the initial distribution of skills, this history-dependence divides each group of otherwise identical households into two perpetually separated groups: one rich and educated, the other poor and uneducated. If the rich have a common interest in the education of the poor (for instance financing public goods), such polarized equilibria are typically Pareto-inefficient. While unconditional transfers only reduce the incentives of the uneducated to accumulate skills, it is shown that there exist activating tax-transfer systems that Pareto-dominate any non-redistributing tax-system and involve a negative marginal income tax on household income below a certain threshold.

Suggested Citation

  • Peter Funk, 2009. "History-Dependent Individual Behavior, Polarization, and Pareto-Improving Activating Welfare," Working Paper Series in Economics 43, University of Cologne, Department of Economics.
  • Handle: RePEc:kls:series:0043
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    References listed on IDEAS

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    1. Paul Beaudry & Charles Blackorby & Dezsö Szalay, 2009. "Taxes and Employment Subsidies in Optimal Redistribution Programs," American Economic Review, American Economic Association, vol. 99(1), pages 216-242, March.
    2. Guy Laroque, 2005. "Income Maintenance and Labor Force Participation," Econometrica, Econometric Society, vol. 73(2), pages 341-376, March.
    3. Wirl, Franz & Feichtinger, Gustav, 2005. "History dependence in concave economies," Journal of Economic Behavior & Organization, Elsevier, vol. 57(4), pages 390-407, August.
    4. Been-Lon Chen, 2007. "Multiple BGPs in a Growth Model with Habit Persistence," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 39(1), pages 25-48, February.
    5. Michael, Robert T, 1973. "Education in Nonmarket Production," Journal of Political Economy, University of Chicago Press, vol. 81(2), pages 306-327, Part I, M.
    6. Sen, Amartya, 1997. "Editorial: Human capital and human capability," World Development, Elsevier, vol. 25(12), pages 1959-1961, December.
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