Abstract:

How should redistributive governments change tax and education policy in response to skill-biased technical change? To answer this question, this paper develops a continuous-type Mirrlees (1971) model with an extensive education choice and endogenous wages. Although we allow tax schedules to be conditioned on education, optimal marginal tax rates are independent from whether individuals are low-skilled or high-skilled. Only the intercepts of the optimal tax functions differ between low-skilled and high-skilled workers. Optimal marginal income tax rates follow the same formula as in Mirrlees (1971). We show that education should optimally be taxed on a net basis. Moreover, optimal tax and education policies do not exploit general-equilibrium effects on the wage distribution to reduce pre-tax earnings differentials. Skill-biased technical raises optimal marginal income tax rates, especially in the middle of the earnings distribution. SBTC has ambiguous effects on net taxes on education as both distributional benefits and distortions simultaneously increase. Numerical simulations demonstrate that, strikingly, optimal income taxes and education subsidies hardly change in response to SBTC. SBTC raises marginal taxes for middle-income groups while net taxes on education may either decrease or increase

Joint work with Uwe Thuemmel

link to paper here