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Income tax, subsidies to education, and investments in human capital in a two-sector economy

  • Mendolicchio, Concetta
  • Paolini, Dimitri
  • Pietra, Tito

The paper studies a two-sector economy with investments in human and physical capital and imperfect labor markets. Workers and firms endogenously select the sector they are active in, and choose the amount of their investments. To enter the high-skill sector, workers must pay a fixed cost that we interpret as direct cost of education. The economy is characterized by two different pecuniary externalities. Given the distribution of the agents across sectors, at equilibrium, in each sector there is underinvestment in both human and physical capital, due to non-contractibility of investments. A second pecuniary externality is induced by the self-selection of the agents in the two sectors. When total factor productivities are sufficiently diverse, subsidies to labor income in the low skill sector and fixed taxes on the direct costs of education increase total surplus, while subsidies to labor income in the high skill sector can actually reduce it.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 14772.

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Date of creation: Mar 2009
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Handle: RePEc:pra:mprapa:14772
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  1. Bas Jacobs & Lans Bovenberg, 2008. "Optimal Taxation of Human Capital and theEarnings Function," CESifo Working Paper Series 2250, CESifo Group Munich.
  2. James J. Heckman & Lance Lochner & Christopher Taber, 1998. "Tax Policy and Human Capital Formation," NBER Working Papers 6462, National Bureau of Economic Research, Inc.
  3. Alan B. Krueger & Mikael Lindahl, 2000. "Education for Growth: Why and For Whom?," NBER Working Papers 7591, National Bureau of Economic Research, Inc.
  4. Lans Bovenberg, A. & Jacobs, Bas, 2005. "Redistribution and education subsidies are Siamese twins," Journal of Public Economics, Elsevier, vol. 89(11-12), pages 2005-2035, December.
  5. A. Lans Bovenberg & Bas Jacobs, 2005. "Redistribution and Education Subsidies are Siamese Twins," Tinbergen Institute Discussion Papers 05-036/3, Tinbergen Institute.
  6. Blankenau, William, 2005. "Public schooling, college subsidies and growth," Journal of Economic Dynamics and Control, Elsevier, vol. 29(3), pages 487-507, March.
  7. Caucutt, Elizabeth M. & Kumar, Krishna B., 2003. "Higher education subsidies and heterogeneity: a dynamic analysis," Journal of Economic Dynamics and Control, Elsevier, vol. 27(8), pages 1459-1502, June.
  8. A. Lans Bovenberg & Bas Jacobs, 2005. "Redistribution and Education Subsidies are Siamese Twins," Tinbergen Institute Discussion Papers 05-036/3, Tinbergen Institute.
  9. Angel de la Fuente & Antonio Ciccone, 2003. "Human capital in a global and knowledge-based economy," Working Papers 70, Barcelona Graduate School of Economics.
  10. Sattinger, Michael, 1993. "Assignment Models of the Distribution of Earnings," Journal of Economic Literature, American Economic Association, vol. 31(2), pages 831-80, June.
  11. William Blankenau & Gabriele Camera, 2009. "Public Spending on Education and the Incentives for Student Achievement," Economica, London School of Economics and Political Science, vol. 76(303), pages 505-527, 07.
  12. Acemoglu, Daron, 1996. "A Microfoundation for Social Increasing Returns in Human Capital Accumulation," The Quarterly Journal of Economics, MIT Press, vol. 111(3), pages 779-804, August.
  13. Anderberg, Dan & Andersson, Fredrik, 2003. "Investments in human capital, wage uncertainty, and public policy," Journal of Public Economics, Elsevier, vol. 87(7-8), pages 1521-1537, August.
  14. Bas Jacobs, 2005. "Optimal Income Taxation with Endogenous Human Capital," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 7(2), pages 295-315, 05.
  15. Zvi Griliches, 1970. "Notes on the Role of Education in Production Functions and Growth Accounting," NBER Chapters, in: Education, Income, and Human Capital, pages 71-127 National Bureau of Economic Research, Inc.
  16. Lucas, Robert Jr., 1988. "On the mechanics of economic development," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 3-42, July.
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