Optimal Progressive Taxation and Education Subsidies in a Model of Endogenous Human Capital Formation

Dirk Krueger and Alexander Ludwig

No 60, Working Paper Series in Economics from University of Cologne, Department of Economics

Abstract: In this paper we characterize quantitatively the optimal mix of progressive income taxes and education subsidies in a model with endogenous human capital formation, borrowing constraints, income risk and incomplete financial markets. Progressive labor income taxes provide social insurance against idiosyncratic income risk and redistributes after tax income among ex-ante heterogeneous households. In addition to the standard distortions of labor supply progressive taxes also impede the incentives to acquire higher education, generating a non-trivial trade-off for the benevolent utilitarian government. The latter distortion can potentially be mitigated by an education subsidy. We find that the welfare-maximizing fiscal policy is indeed characterized by a substantially progressive labor income tax code and a positive subsidy for college education. Both the degree of tax progressivity and the education subsidy are larger than in the current U.S. status quo.

Keywords: Progressive Taxation; Capital Taxation; Optimal Taxation (search for similar items in EconPapers)
JEL-codes: E62 H21 H24 (search for similar items in EconPapers)
Date: 2013-03-27
New Economics Papers: this item is included in nep-dge, nep-mac, nep-pbe and nep-pub
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Citations: View citations in EconPapers (26)

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Related works:
Working Paper: Optimal Progressive Taxation and Education Subsidies in a Model of Endogenous Human Capital Formation (2013)
Working Paper: Optimal Progressive Taxation and Education Subsidies in a Model of Endogenous Human Capital Formation (2010)
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