In a two-period life-cycle model with ex ante homogeneous households, earnings risk, and a general earnings function, we derive the optimal linear labor tax rate and optimal linear education subsidies. The optimal income tax trades off social insurance against incentives to work. Education subsidies are not used for social insurance, but they are only targeted at offsetting the distortions of the labor tax and internalizing a fiscal externality. Both optimal education subsidies and tax rates increase if labor and education are more complementary, because education subsidies indirectly lower labor tax distortions by stimulating labor supply. Optimal education subsidies (taxes) also correct non-tax distortions arising from missing insurance markets. Education subsidies internalize a positive (negative) fiscal externality if there is underinvestment (overinvestment) in education because of risk. Education policy unambiguously allows for more social insurance if education is a risky activity. However, if education hedges against labor-market risk, optimal tax rates could be lower than in the case without education subsidies.

Additional Metadata
Keywords Education subsidies, human-capital investment, idiosyncratic risk, labor taxation risk properties of human capit
JEL Efficiency; Optimal Taxation (jel H21), Education and Research Institutions (jel I2), Time Allocation, Work Behavior, and Employment Determination and Creation; Human Capital (jel J2)
Persistent URL hdl.handle.net/1765/124522
Journal Scandinavian Journal of Economics
Citation
Jacobs, B, Schindler, D.S., & Yang, H. (2012). Optimal Taxation of Risky Human Capital. Scandinavian Journal of Economics, 114(3), 908–931. Retrieved from http://hdl.handle.net/1765/124522