Taxing Human Capital Efficiently – The Double Dividend of Taxing Nonqualified Labour More Heavily Than Qualified Labour

Abstract

Assuming isoelastic returns to education and an endogenous supply of qualified and nonqualified labour, it is shown to be second-best efficient not to distort the choice of education. Furthermore, taxation should set incentives so that qualified labour is substituted for nonqualified labour. As a result, it is efficient to tax labour income regressively with respect to qualification and to tax the monetary cost of education at a level that restores efficiency in education. Atax on capital income alleviates the distortion that progressive taxation of labour income exerts on human-capital investment.Endogenous choice of education and labour, efficient taxation of human and nonhuman capital, double-dividend hypothesis