Taxation and the intergenerational transmission of human capital

Abstract

How do taxes affect human capital accumulation? This question has been studied extensively in the context of two model classes: overlapping generations (OLG) and infinite horizon (IH) models. These embody very different assumptions about the intergenerational transmission of physical and human capital. OLG models typically abstract from intergenerational linkages, while IH models implicitly assume that new agents inherit human and physical capital from their parents. This paper investigates how such differences in intercohort persistence affect the responsiveness of human capital to taxation. A model is developed that nests OLG and IH models as special cases. Analytical expressions for the steady state tax elasticities of human capital are derived for versions of the model with varying degrees of persistence. The main finding is that higher persistence increases the responsiveness of human capital to both wage and capital income taxes. As a result, IH models generate larger tax elasticities than do OLG models with incomplete persistence, even if cohorts are altruistically linked. In a calibrated version of the model, moving from no persistence to complete persistence increases the tax elasticity of human capital by a factor between two and three.