Shaping inequality: Progressive taxation under human capital accumulation

Abstract

This paper develops a model of human capital accumulation with on-the-job learning subject to obsolescence risk. The model analytically characterizes trade-offs of reforming the level of income tax progressivity and matches well income inequality in the US. An enriched version is used to quantitatively investigate optimal tax progressivity in the US. In contrast to standard models with exogenous income which suggest that progressivity is too low, accounting for endogenous human capital accumulation would call for lower tax progressivity. While optimal from a utilitarian perspective, such a reform mostly benefits individuals at the top 10\% of the earnings distribution, however.

Keywords: income inequality, fat tails, progressive income taxation, human capital accumulation

JEL Classification: D3, C46, E24, J24, H2