Kreider, Brent

Economic Inquiry Vol. 46 no. 4 (October 2008): 660-675.

This paper studies how optimal wage tax conclusions from the classic two-period life-cycle model of human capital accumulation are affected by endogenizing the number of taxpaying workers. In the absence of a corrective policy, young individuals underinvest in human capital from a social perspective because tax premiums for transfers to nonworkers are not actuarially adjusted downward for human capital attainment. Compensated wage taxes and subsidies can restore proper price signals. Numerical simulations suggest that even modest extensive margin employment elasticities can be sufficient to substantially impact the magnitudes and even the signs of optimal wage tax rates.