Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/71176
Authors: 
Jacobs, Bas
Yang, Hongyan
Year of Publication: 
2013
Series/Report no.: 
CESifo Working Paper: Public Finance 4155
Abstract: 
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.
Subjects: 
labor taxation
human capital investment
credit constraints
JEL: 
H21
I20
J20
Document Type: 
Working Paper

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