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Optimal Taxation with Risky Human Capital

Marek Kapicka and Julian Neira ()

No 1504, Discussion Papers from University of Exeter, Department of Economics

Abstract: We study optimal tax policies in a life-cycle economy with risky human capital and permanent ability differences, where both ability and learning effort are private information of the agents. The optimal policies balance several goals: redistribution across agents, insurance against human capital shocks, incentives to accumulate human capital, and incentives to work. We show that, in the optimum, i) high-ability agents face risky consumption in order to elicit learning effort while low-ability agents are insured, ii) high-ability agents face a higher savings tax to discourage them from self-insuring, iii) under certain conditions, the inverse marginal labor income tax rate follows a random walk, and iv) the “no distortion at the top” result does not apply if discouraging labor supply increases incentives to invest in human capital. Quantitatively, we find large welfare gains for the U.S. from switching to an optimal tax system.

Keywords: optimal taxation; income taxation; human capital (search for similar items in EconPapers)
JEL-codes: E6 H2 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-dge, nep-hrm, nep-mac, nep-pbe and nep-pub
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http://people.exeter.ac.uk/RePEc/dpapers/DP1504.pdf (application/pdf)

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Journal Article: Optimal Taxation with Risky Human Capital (2019) Downloads
Working Paper: Optimal Taxation with Risky Human Capital (2015) Downloads
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