Optimal Taxation of Risky Human Capital
Tilburg University, CentER; Netspar; University of Amsterdam - Amsterdam School of Economics (ASE); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
University of Konstanz - Faculty of Economics and Statistics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
University of Konstanz
January 1, 2009
CESifo Working Paper Series No. 2529
In a model with ex-ante homogenous households, earnings risk and a general earnings function, we derive the optimal linear labor tax rate and optimal linear education subsidies. The optimal income tax trades off social insurance against incentives to work and to invest in human capital. Education subsidies are not used for social insurance, but are only targeted at off-setting the distortions of the labor tax and internalizing a fiscal externality. Both optimal education subsidies and tax rates increase if labor and education are more complementary, since education subsidies indirectly lower labor tax distortions by stimulating labor supply. Optimal education subsidies (taxes) also correct non-tax distortions arising from missing insurance markets. Education subsidies internalize a positive (negative) fiscal externality if there is underinvestment (overinvestment) in education due to risk. Education policy unambiguously allows for more social insurance if education is a risky activity. However, if education hedges against labor market risk, optimal tax rates could be lower than without education subsidies.
Number of Pages in PDF File: 33
Keywords: labor taxation, human capital investment, education subsidies, idiosyncratic risk, risk properties of human capital
JEL Classification: H21, I2, J2working papers series
Date posted: January 27, 2009
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