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Endogenous Credit Constraints, Human Capital Investment and Optimal Tax Policy

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  • Hongyan Yang

    () (Department of Economics, University of Konstanz, Germany)

Abstract

This paper employs a two-period life-cycle model to derive the optimal tax policy when educational investments are subject to credit constraints. Credit constraints arise from the limited commitment of debitors to repay loans and are endogenously determined by private banks under the non-default condition that individuals can-not be better off by defaulting. We show that the optimal redistributive taxation trades the welfare gain of reducing borrowing demand and of changing the credit constraints against the efficiency costs of distorting education and labor supply. In addition, we compare the optimal taxation with that when credit constraints are taken as given. If income taxation decreases (increases) the borrowing limit, taking credit constraints as given leads to a too high (low) labor tax rate. Thus, ignoring the effects of tax policy on credit constraints overestimates (underestimates) the welfare effects of income taxation. Numerical examples show that income taxation tightens the credit constraints and the optimal tax rates are lower when credit constrains are endogenized. The intuition is that redistributive taxation reduces the incentive to invest in education and to work, thus exaggerating the moral hazard problems associated with credit constraints.

Suggested Citation

  • Hongyan Yang, 2010. "Endogenous Credit Constraints, Human Capital Investment and Optimal Tax Policy," Working Paper Series of the Department of Economics, University of Konstanz 2010-04, Department of Economics, University of Konstanz.
  • Handle: RePEc:knz:dpteco:1004
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    File URL: http://www.uni-konstanz.de/FuF/wiwi/workingpaperseries/WP_Yang-4-10.pdf
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    References listed on IDEAS

    as
    1. Wilbert van der Klaauw, 2002. "Estimating the Effect of Financial Aid Offers on College Enrollment: A Regression-Discontinuity Approach," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 43(4), pages 1249-1287, November.
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    More about this item

    Keywords

    labor taxation; human capital investment; credit constraints;

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • I2 - Health, Education, and Welfare - - Education
    • J2 - Labor and Demographic Economics - - Demand and Supply of Labor

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