Abstract
This paper derives optimal labor taxation to finance student transfer if educational investments are subject to credit constraints. Credit constraints are endogenously determined under the incentive constraint that individuals cannot be better-off by defaulting. Student transfer alleviates credit constraints by reducing students' need to borrow, but taxing labor can reduce private credit limit by exaggerating moral hazard problems associated with credit constraints. Numerical examples show that labor taxation tightens credit limit, especially if education is important, labor is elastic and if a large share of earnings can be seized in case of default. Consequently, the optimal tax rates should be lower.
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