Optimal linear income taxes and education subsidies under skill-biased technical change

• Published in: International tax and public finance Vol. 30; no. 6; pp. 1529 - 1575
• Main Authors: Jacobs, Bas, Thuemmel, Uwe
• Format: Journal Article
• Language: English
• Published: New York Springer US 01.12.2023; Springer Nature B.V
• Subjects: Ambiguity; Bias; Business Taxation/Tax Law; Economics; Economics and Finance; Education policy; Equilibrium; Higher education; Income inequality; Income redistribution; Income taxes; Labor supply; Optimal taxation; Public Finance; Simulation; Skilled workers; Subsidies; Tax rates; Taxation; Wages & salaries; United States > US; Human capital; Optimal taxation; O3; Technological change; J2; I2; Education subsidies; H2; H5; General equilibrium
• ISSN: 0927-5940; 1573-6970
• DOI: 10.1007/s10797-022-09756-8

This paper studies how linear tax and education policy should optimally respond to skill-biased technical change (SBTC). SBTC affects optimal taxes and subsidies by changing (1) direct distributional benefits of each policy instrument, (2) indirect, general-equilibrium effects on wages, and (3) education distortions. Analytically, the effect of SBTC on these three components is shown to be ambiguous. In simulations for the US economy, SBTC makes the optimal tax system more progressive and lowers optimal education subsidies. This is because for both income taxes and education subsidies; their direct distributional effects become more important, which more than offsets the larger general-equilibrium effects and increased education distortions.