Optimal Progressive Taxation and Education Subsidies in a Model of Endogenous Human Capital Formation

Posted: 17 May 2013

See all articles by Dirk Krueger

Dirk Krueger

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Alexander Ludwig

Leibniz Institute for Financial Research SAFE; University of Cologne - Faculty of Management, Economics and Social Sciences

Date Written: March 27, 2013

Abstract

In this paper we characterize quantitativelya the optimal mix of progressive income taxes and education subsidies in a model with endogeneous himan 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 heterogenous households. In addition to the standard distortions of labor supply progressive taxes also impede the incentives to acquire higher education, generation a non-trivial trade-off for the benevolent utilitatian 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. Both the degree of tax progressivity and the education subsidy are larger than in the current U.S. status quo.

Keywords: Progressive Taxation, Capital Taxation, Optimal Taxation

JEL Classification: E62, H21, H24

Suggested Citation

Krueger, Dirk and Ludwig, Alexander, Optimal Progressive Taxation and Education Subsidies in a Model of Endogenous Human Capital Formation (March 27, 2013). MEA Discussion Paper No. 267, Available at SSRN: https://ssrn.com/abstract=2265944 or http://dx.doi.org/10.2139/ssrn.2265944

Dirk Krueger (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6691 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~dkrueger/

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Alexander Ludwig

Leibniz Institute for Financial Research SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

University of Cologne - Faculty of Management, Economics and Social Sciences ( email )

Albertus-Magnus-Platz
Cologne, D-50923
Germany

HOME PAGE: http://www.wiso.uni-koeln.de/cmr/alexludwig

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