Optimal Mirrleesean Taxation with Unobservable Human Capital Formation

Economics

Speaker:	Marek Kapicka, University of California, Santa Barbara
Date:	Wednesday 26 March 2014
Time:	16.00
Location:	Matrix Lecture Theatre, Building One

Further details

I characterize the optimal income taxes in a dynamic life-cycle economy where people have private information about both their ability and human capital. I show that unobservable human capital effectively makes preferences over labor supply nonseparable across age. I generalize the static optimal tax formulas to account for such nonseparabilities, and show that they depend not only on own-Frisch elasticities labor, but also on cross-Frisch elasticities of labor. I study two examples showing how unobservable human capital formation determines the Frisch elasticities. I calibrate the economy to U.S. data and solve numerically for the optimal taxes. I find that the optimal marginal income taxes decrease with age, in contrast to the U.S. tax code, but also in contrast to a model with observable human capital. In addition, the marginal taxes decline faster for high ability agents. I demonstrate that the behavior of cross-Frisch elasticities of labor is essential in explaining the decline.