Topics in human capital and taxation: effective tax rates on education, the heterogeneous human capital model and the impact of nominal rigidities in the tax system

Abstract

In this thesis I address several neglected issues relating to the theoretical and applied analysis of human capital and the impact of taxation. I begin with the problem of measuring the effective tax rate on human capital accumulation. I develop a forward-looking measure of the effective tax rate that is grounded in human capital theory, allowing for features that differentiate human capital formation from physical capital formation. These features include concavity of the earnings-investment frontier and adjustments in capital utilization through leisure. I argue that the few attempts that have been made to measure the effective tax rate on skill formation are either limited by the fact that they inherit assumptions applicable to the theory of the firm or have dubious theoretical foundations (Chapter Two). The new measure is used to derive the effective tax rate on human capital in 25 OECD countries, including Australia (Chapter Three).

While there are numerous general equilibrium models which integrate nominal rigidities of one form or another, little attention has been devoted to nominal rigidities arising from partial indexation of income tax thresholds. No doubt one of the reasons for this gap in the literature is the difficulty associated with introducing a fully specified progressive tax regime into an applied general equilibrium model. I show that this hurdle can be overcome through a zero-profit condition for general equilibrium on the labour market. The condition is integrated into an aggregative model of the economy consisting of two sectors (consumption and education) and two factors of production (skilled and unskilled labour). Since skill formation is endogenous, the model allows us to reopen research into the optimal level of skill formation and the role of government (Chapter Four). An applied general equilibrium version of the model is used to evaluate the impact of recent tax reform proposals on skill formation (Chapter Five).

A concluding chapter draws together these lines of enquiry with suggestions for future research (Chapter Six).