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Optimal Wealth Taxes with Risky Human Capital

  • Borys Grochulski
  • Tomasz Piskorski

We study the structure of optimal wedges and wealth taxes in a Mirrleesian economy with endogenous skills. Human capital is a private state variable that drives the skill process of each individual. Building on the findings of the labor literature, we assume that human capital investment is a) risky, b), done early in the life-cycle, and c) indistinguishable from consumption. These assumptions lead to the optimality of a) a human capital premium, i.e., an excess return on human capital relative to physical capital, b) a large intertemporal wedge early in the life-cycle stemming from the lack of Rogerson's (1985) "inverse Euler" characterization of the optimal consumption process, and c) an intra-temporal distortion of the effort/consumption margin even at the top of the skill distribution at all dates except of the terminal date. The main implication for the structure of linear wealth taxes is the necessity of deferred taxation of wealth. In particular, deferred taxation of wealth prevents the agents from making a joint deviation of under-investing in human capital ex ante and shirking at some future date in the life-cycle, as the marginal differed tax rate on wealth held early in the life-cycle is history-dependent. Also, the present value of aggregate marginal tax rate is zero at all dates, which means that, as in Kocherlakota (2005), the government revenue from wealth taxation is zero. Relative to economies with exogenous skills, the optimal marginal wealth tax rate is more volatile

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 59.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:59
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  1. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 1-30.
  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. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2002. "Optimal Indirect and Capital Taxation," Levine's Working Paper Archive 391749000000000449, David K. Levine.
  4. Narayana R Kocherlakota, 2005. "Advances in Dynamic Optimal Taxation," Levine's Bibliography 784828000000000518, UCLA Department of Economics.
  5. Narayana Kocherlakota, 2004. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Levine's Bibliography 122247000000000729, UCLA Department of Economics.
  6. Larry E. Jones & Rodolfo E. Manuelli & Peter E. Rossi, 1993. "On the Optimal Taxation of Capital Income," NBER Working Papers 4525, National Bureau of Economic Research, Inc.
  7. Ignacio Palacios-Huerta, 2001. "An Empirical Analysis of the Risk Properties of Human Capital Returns," Working Papers 2001-10, Brown University, Department of Economics.
  8. Michele Boldrin & Ana Montes, 2005. "The Intergenerational State Education and Pensions," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 651-664.
  9. Narayana R. Kocherlakota, 2004. "Wedges and Taxes," American Economic Review, American Economic Association, vol. 94(2), pages 109-113, May.
  10. 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 S11-44, August.
  11. Stefania Albanesi, 2006. "Optimal Taxation of Entrepreneurial Capital with Private Information," NBER Working Papers 12419, National Bureau of Economic Research, Inc.
  12. Emmanuel Farhi & Ivan Werning, 2006. "Progressive Estate Taxation," NBER Working Papers 12600, National Bureau of Economic Research, Inc.
  13. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
  14. Mirrlees, James A, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Wiley Blackwell, vol. 38(114), pages 175-208, April.
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