Tax smoothing in a business cycle model with capital-skill complementarity

Abstract

This paper undertakes a normative investigation of the quantitative properties of optimal tax smoothing in a business cycle model with state contingent debt, capital-skill complementarity and endogenous skill acquisition under technology and public expenditure shocks. We find that skilled and unskilled labour tax smoothing maintain quantitatively under externalities and exogenous shocks in skill acquisition, as well as when the relative skill supply is exogenously determined. We further find that the government finds it optimal to reduce both the size of the wedge between the marginal rates of substitution and transformation in skill attainment in the long-run and the standard deviation of this wedge over the business cycle. This is achieved by subsidising skill creation and taxing both types of labour income

Human Capital Accumulation and Transition to Skilled Employment

“…We use a closed-economy setup where a representative household is an in…nitely-lived dynasty with both types of workers/members. 4 These members di¤er in the type of labour services they o¤er. Unskilled workers accumulate human capital as a function of time and expenditure allocated to education.…”

“…Goldin and Katz (2008) and Krusell et al (2000)). Moreover, skilled and 4 The modelling assumption that the population is made up by a representative household composed of members which di¤er in their labour market position is a standard modelling device in dynamic macroeconomic models with two-state heterogeneity in the labour market since Merz (1995). Examples include the models incorporating search and matching labour market frictions and unemployment (see e.g.…”

“…Quadrini (2000) and Kambourov and Manovskii (2009)) and of the skill premium (see e.g. Lindquist (2004), Pourpourides (2011) and Angelopoulos et al (2015)). …”

Optimal Progressive Taxation in a Model with Endogenous Skill Supply

“…3 In particular, we assume that a representative household decides how to allocate its expenditure into investment in the two types of capital stock and into goods for creating skilled labour. Moreover, it decides how to allocate its time endowment into leisure, work time in skill and unskilled jobs, and in education or training for creating skilled labour.…”

“…In other recent work, Angelopoulos et al (2014), we analyse optimal tax smoothing under skill heterogeneity and capital-skill complementarity, when the government has access to state-contingent debt and a complete set of state-contingent tax instruments. This is carried out in a stochastic environment with endogenous and exogenous skill supply by di¤erent workers, under externalities in skill creation.…”