Income Taxes, Subsidies to Education, and Investments in Human Capital

32 Pages Posted: 8 May 2010

See all articles by Concetta Mendolicchio

Concetta Mendolicchio

University of Genoa - DIEC

Dimitri Paolini

DiSea & CRENOS, Università di Sassari; Catholic University of Louvain (UCL) - Center for Operations Research and Econometrics (CORE)

Tito Pietra

University of Bologna - Department of Economics

Date Written: January 24, 2010

Abstract

We study a two-sector economy with investments in human and physical capital and imperfect labor markets. Human and physical capital are heterogeneous. Workers and firms endogenously select the sector they are active in, and choose the amount of their sector-specific investments in human and physical capital. To enter the high-skill sector, workers must pay a fixed cost that we interpret as direct cost of education. Given the distribution of the agents across sectors, at equilibrium, in each sector there is underinvestment in both human and physical capital, due to non-contractibility of investments. A second source of inefficiency is related to the self-selection of the agents into the two sectors. It typically induces too many workers to invest in education. Under suitable restrictions on the parameters, the joint effect of the two distortions is that equilibria are characterized by too many people investing too little effort in the high skill sector.

We also analyze the welfare properties of equilibria and study the effects of several tax-subsidy policies on the total expected surplus.

Keywords: Human capital, Efficiency, Labour income tax

JEL Classification: J24, H2

Suggested Citation

Mendolicchio, Concetta and Paolini, Dimitri and Pietra, Tito, Income Taxes, Subsidies to Education, and Investments in Human Capital (January 24, 2010). Available at SSRN: https://ssrn.com/abstract=1601049 or http://dx.doi.org/10.2139/ssrn.1601049

Concetta Mendolicchio

University of Genoa - DIEC ( email )

Italy
003901020955228  (Phone)

Dimitri Paolini

DiSea & CRENOS, Università di Sassari ( email )

Piazza Universita
Sassari, 07100
Italy

Catholic University of Louvain (UCL) - Center for Operations Research and Econometrics (CORE) ( email )

34 Voie du Roman Pays
B-1348 Louvain-la-Neuve, b-1348
Belgium

Tito Pietra (Contact Author)

University of Bologna - Department of Economics ( email )

Strada Maggiore 45
Bologna, 40125
Italy

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