Endogenous credit constraints, human capital investment and optimal tax policy

Yang, Hongyan

Endogenous credit constraints, human capital investment and optimal tax policy

Files

Yang_134367.pdf(320.69 KB)

Date

2010

Authors

Yang, Hongyan

Series

Working Paper Series / Department of Economics; 2010-04

Publication type

Working Paper/Technical Report

Abstract

This paper employs a two-period life-cycle model to derive the optimal tax policy when educational investments are subject to credit constraints. Credit constraints arise from the limited commitment of debitors to repay loans and are endogenously determined by private banks under the non-default condition that individuals can-not be better off by defaulting. We show that the optimal redistributive taxation trades the welfare gain of reducing borrowing demand and of changing the credit constraints against the efficiency costs of distorting education and labor supply. In addition, we compare the optimal taxation with that when credit constraints are taken as given. If income taxation decreases (increases) the borrowing limit, taking credit constraints as given leads to a too high (low) labor tax rate. Thus, ignoring the effects of tax policy on credit constraints overestimates (underestimates) the welfare effects of income taxation. Numerical examples show that income taxation tightens the credit constraints and the optimal tax rates are lower when credit constrains are endogenized. The intuition is that redistributive taxation reduces the incentive to invest in education and to work, thus exaggerating the moral hazard problems associated with credit constraints.

Subject (DDC)

330 Economics

Keywords

labor taxation,human capital investment,credit constraints

Cite This

ISO 690

YANG, Hongyan, 2010. Endogenous credit constraints, human capital investment and optimal tax policy

BibTex

@techreport{Yang2010Endog-13436,
  year={2010},
  series={Working Paper Series / Department of Economics},
  title={Endogenous credit constraints, human capital investment and optimal tax policy},
  number={2010-04},
  author={Yang, Hongyan}
}

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    <dcterms:abstract xml:lang="eng">This paper employs a two-period life-cycle model to derive the optimal tax policy when educational investments are subject to credit constraints. Credit constraints arise from the limited commitment of debitors to repay loans and are endogenously determined by private banks under the non-default condition that individuals can-not be better off by defaulting. We show that the optimal redistributive taxation trades the welfare gain of reducing borrowing demand and of changing the credit constraints against the efficiency costs of distorting education and labor supply. In addition, we compare the optimal taxation with that when credit constraints are taken as given. If income taxation decreases (increases) the borrowing limit, taking credit constraints as given leads to a too high (low) labor tax rate. Thus, ignoring the effects of tax policy on credit constraints overestimates (underestimates) the welfare effects of income taxation. Numerical examples show that income taxation tightens the credit constraints and the optimal tax rates are lower when credit constrains are endogenized. The intuition is that redistributive taxation reduces the incentive to invest in education and to work, thus exaggerating the moral hazard problems associated with credit constraints.</dcterms:abstract>
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Bibliography of Konstanz

Yes