Risky Human Capital and Deferred Capital Income Taxation

66 Pages Posted: 7 Dec 2012

See all articles by Borys Grochulski

Borys Grochulski

Federal Reserve Banks - Federal Reserve Bank of Richmond

Tomasz Piskorski

Columbia University - Columbia Business School, Finance

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2006

Abstract

We study the structure of optimal wedges and capital taxes in a Mirrlees 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) made early in the life-cycle, and c) hard to distinguish 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 [Econometrica, 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 the terminal date. The main implication for the structure of linear capital taxes is the necessity of deferred taxation of physical capital. In particular, deferred taxation of capital prevents the agents from making a joint deviation of under-investing in human capital ex ante and shirking from labor effort at some future date in the life-cycle, as the marginal deferred tax rate on physical capital held early in the life-cycle is history-dependent. The average marginal tax rate on physical capital held in every period is zero in present value. Thus, as in Kocherlakota [Econometrica, 2005], the government revenue from capital taxation is zero. However, since a portion of the capital tax must be deferred, expected capital tax payments cannot be zero in every period. Necessarily, agents face negative expected capital tax payments due early in the life-cycle and positive expected capital tax payments late in the life-cycle. Also, relative to economies with exogenous skills, the optimal marginal wealth tax rate is more volatile.

Keywords: optimal taxation, private information, human capital, deferred tax

JEL Classification: E62, H21, J24

Suggested Citation

Grochulski, Borys and Piskorski, Tomasz, Risky Human Capital and Deferred Capital Income Taxation (December 1, 2006). FRB Richmond Working Paper No. 06-13, Available at SSRN: https://ssrn.com/abstract=2186153 or http://dx.doi.org/10.2139/ssrn.2186153

Borys Grochulski (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

HOME PAGE: http://www.richmondfed.org/research/economists/bios/grochulski_bio.cfm

Tomasz Piskorski

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

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