Redistribution and Education Subsidies are Siamese Twins

Abstract

We develop a model of human capital formation with endogenous labor supply and heterogeneous agents to explore the optimal level of education subsidies along with the optimal schedule of the labor income tax. If the government can observe inputs into the production of human capital, subsidies on education ensure efficiency in human capital accumulation and labor taxes are more progressive than without education policies. Although the able benefit more than proportionally from education subsidies, education subsidies thus play an important role in alleviating the tax distortions in human capital accumulation induced by redistributive policies. If the government can not verify all investments in human capital, education policy offsets some but not all the tax-induced distortions on learning.