Marginal Welfare Costs of Taxation with Human and Physical Capital

Sam Allgood and Arthur Snow

Economic Inquiry, 2006, vol. 44, issue 3, pages 451-464

Abstract: We develop a perfect foresight, overlapping generations model with intragenerational inequality and endogenous human and physical capital investment, and we calculate welfare costs for marginal reforms of taxation and public spending. Welfare costs are uniformly lower than in the equivalent static model where human and physical capital are fixed. Most of the upward bias in static estimates arises from fixed human capital because welfare cost is predominantly tax leakage from lower effective labor supply, but reallocating time between education and labor can leave effective labor supply unchanged. Hence, adjustments in human capital have an important mitigating influence on marginal welfare costs. (JEL D91, H20, H31, H41, J22, J24) Copyright 2006, Oxford University Press.

JEL-codes: D91 H20 H31 H41 J22 J24 (search for similar items in EconPapers)

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