Optimal factor tax incidence in two-sector human capital-based models

Been-Lon Chen and Chia-Hui Lu

Journal of Public Economics, 2013, vol. 97, issue C, 75-94

Abstract: This paper studies the optimal factor tax incidence in a standard two-sector, human capital-based endogenous growth model elucidated by Lucas (1988). Capital income taxes generate dynamic inefficiency for capital accumulation and labor income taxes create dynamic inefficiency for human capital accumulation. A factor tax incidence is a tradeoff between these two inefficiencies. A switch from capital income taxes to labor income taxes reduces the long-run welfare coming from lower leisure and increases the long-run welfare originated from higher economic growth and higher consumption. Because the representative agent's learning time and human capital are inseparable and thus affect learning activities at the same degree, we find that based on the current US income tax code, it is optimal to first tax capital income, and to resort to taxing labor income only when tax revenue is insufficient to cover government expenditure.

Keywords: Two-sector model; Human capital; Optimal factor tax incidence (search for similar items in EconPapers)
JEL-codes: E62 H22 O41 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (22)

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Working Paper: Optimal Factor Tax Incidence in Two-sector Human Capital-based Models (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:pubeco:v:97:y:2013:i:c:p:75-94

DOI: 10.1016/j.jpubeco.2012.09.008

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