Optimal Taxation with Risky Human Capital

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) if utility is separable in labor and learning effort, the inverse marginal labor income tax rate follows a random walk, ii) the "no distortion at the top" result does not apply if discouraging labor supply increases incentives to invest in human capital, and iii) quantitatively, high-ability agents face very risky consumption in order to elicit learning effort while low-ability agents are insured. We also find large welfare gains for the U.S. from switching to an optimal tax system. J.E.L. Codes: E6, H2

Dynamic Taxation

“…Stantcheva (2015a) instead considers time investment in human capital. Kapicka & Neira (2014) propose a human capital accumulation process with time investments and a fixed ability, and they consider the case in which the effort spent to acquire human capital is unobservable. Perrault (2015) considers loss of human capital from unemployment.…”

A Road Map for Efficiently Taxing Heterogeneous Agents

“…Peterman (2012) analyzes laborand capital-income taxes in the presence of human capital, while Kapička and Neira (2015) study optimal tax policies with an emphasis on risky human capital accumulation. Krueger and Ludwig (2013) analyze progressive taxation with endogenous education decisions.…”

Designing Efficient College and Tax Policies

“…Saez (2002) and Jacquet, Lehmann, and Van der Linden (2013) consider the labor force participation margin, Kleven, Kreiner, and Saez (2009) consider labor force participation of the secondary earner, Scheuer (2014) considers the occupational choice margin and Lehmann, Simula, and Trannoy (2014) consider migration. Stantcheva (2014Stantcheva ( , 2015b, Kapicka and Neira (2015) and Findeisen and Sachs (2015a) consider models of optimal taxation with education in the "New Dynamic Public Finance" (NPDF) tradition with endogenous policy instruments. Our paper differs in that we explicitly consider college as an education decision and also analyze simpler policy instruments as opposed to solely focusing on the second-best.…”