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Optimal Income Taxation with Human Capital Accumulation and Limited Record Keeping

Marek Kapicka

Review of Economic Dynamics, 2006, vol. 9, issue 4, 612-639

Abstract: This paper characterizes optimal income taxes in a dynamic economy where human capital is unobservable and the government is restricted to use taxes that depend only on current income. I show that unobservability of human capital tends to decrease the labor wedge, while the effect on the human capital wedge is uncertain. I also analyze the relationship between optimal taxes in economies with and without endogenous human capital and identify two qualitative reasons why the optimal tax codes will differ. I perform numerical simulations to calculate the quantitative relevance of endogenous human capital formation for optimal tax policy. I find that endogenous human capital lowers marginal tax rates by about 9% on average, as compared with a static model without human capital. (Copyright: Elsevier)

Keywords: Optimal taxation; Income taxation; Human capital (search for similar items in EconPapers)
JEL-codes: E6 H2 (search for similar items in EconPapers)
Date: 2006
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DOI: 10.1016/j.red.2006.05.003

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