Second-Best Income Taxation with Endogenous Human Capital and Borrowing Constraints

Arbeitspapier

We formulate a two-period life-cycle model of saving, labor supply, and human capital investments when individuals differ in ability and initial wealth. Borrowing constraints prevent individuals to optimally smooth consumption over the life-cycle and to optimally invest in human capital. We show that the optimal linear income tax is positive - even in the absence of any redistributional concerns. A progressive income tax is efficient because it relaxes borrowing constraints by redistributing resources from the unconstrained to the borrowing constrained stages of the life-cycle. Hence, consumption is smoothed better and investments in human capital increase. The progressive income tax is a second-best instrument to correct the non-tax distortion in the capital market. The equity-efficiency trade-off is therefore less severe when progressive income taxes mitigate capital market imperfections. Simulations demonstrate that optimal income taxes are substantially higher when they alleviate credit constraints.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: CESifo Working Paper ; No. 4155

Classification and Topics

• Classification: Wirtschaft ; Taxation and Subsidies: Efficiency; Optimal Taxation ; Education and Research Institutions: General ; Demand and Supply of Labor: General
• Subject: labor taxation ; human capital investment ; credit constraints

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Jacobs, Bas ; Yang, Hongyan
• Event: Veröffentlichung
• (who): Center for Economic Studies and ifo Institute (CESifo)
• (where): Munich
• (when): 2013

Further information

• Handle: http://hdl.handle.net/10419/71176
• Last update: 10.03.2025, 11:45 AM CET