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Optimal Capital and Progressive Labor Income Taxation with Endogenous Schooling Decisions and Intergenerational Transfers

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  • Alexander Ludwig

    (Goethe University Frankfurt)

  • Dirk Krueger

    (University of Pennsylvania)

Abstract

In this paper we characterize quantitatively the optimal mix of progressive labor income and capital income taxes as well as and education subsidies in a model with endogenous human capital formation, borrowing constraints, income risk. and incomplete financial markets. Progressive labor income taxes provide social insurance against idiosyncratic income risk and redistributes after tax income among ex-ante heterogeneous households. In addition to the standard distortions of labor supply progressive taxes also impede the incentives to acquire higher education, generating a non-trivial trade-off for the benevolent utilitarian government. The latter distortion can potentially be mitigated by an education subsidy. We find that the welfare-maximizing fiscal policy is indeed characterized by a substantially progressive labor income tax code and a positive subsidy for college education. The optimal degree of the education subsidy is larger than in the current U.S. status quo.

Suggested Citation

  • Alexander Ludwig & Dirk Krueger, 2015. "Optimal Capital and Progressive Labor Income Taxation with Endogenous Schooling Decisions and Intergenerational Transfers," 2015 Meeting Papers 334, Society for Economic Dynamics.
    • Handle: RePEc:red:sed015:334
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    2. Julian Kozlowski & Diego Daruich, 2016. "Explaining Income Inequality and Intergenerational Mobility: The Role of Fertility and Family Transfers," 2016 Meeting Papers 665, Society for Economic Dynamics.
    3. Diego Daruich, 2017. "From Childhood to Adult Inequality: Parental Investments and Early Childhood Development," 2017 Meeting Papers 770, Society for Economic Dynamics.

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