Human Capital and Optimal Redistribution

Abstract

We characterize optimal redistribution in a dynastic family model with human capital. We show how a government can improve the trade-off between equality and incentives by changing the amount of observable human capital. We provide an intuitive decomposition for the wedge between human-capital investment in the laissez faire and the social optimum. This wedge differs from the wedge for bequests because human capital carries risk: its returns depend on the non-diversi…able risk of children'’s ability. Thus, human capital investment is encouraged more than bequests in the social optimum if human capital is a bad hedge for consumption risk.

Keywords: human capital, optimal taxation

JEL Classification: E24, H21, I22, J24