Taxing Education in Ramsey's Tradition

Abstract

Assuming a two-period model with endogenous choices of labour, education, and saving, it is shown to be second-best efficient to deviate from Ramsey's Rule and to distort qualified labour less than nonqualified labour. Furthermore, if the earnings function displays constant elasticity, the choice of education should not be distorted. With the necessary qualifications the results extend to the case when taxpayers are heterogeneous and when the planner trades off efficiency against equity.Endogenous choice of education, labour, and saving; second-best efficient taxation; linear instruments; finite periods; Ramsey's Rule; Power Law of Learning