Estimates of Marginal Welfare Costs of Taxation with Investment in Human and Physical Capital

Co-Authored by: Snow, Arthur

We develop a perfect foresight, overlapping generations model with intragenerational inequality and endogenous human and physical capital investment, and we calculate welfare costs for marginal reforms of taxation and public spending. Welfare costs are uniformly lower than in the equivalent static model where human and physical capital are fixed. Most of the upward bias in static estimates arises from fixed human capital because welfare cost is predominantly tax leakage from lower effective labor supply, but reallocating time between education and labor can leave effective labor supply unchanged. Hence, adjustments in human capital have an important mitigating influence on marginal welfare costs.

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	Allgood, Sam Professor of Economics Expertise: Economic Education Labor Economics (wages, employment, working conditions, unions) Managerial Economics Public Finance Economics CBA 369 P.O. Box 880489 University of Nebraska-Lincoln Lincoln, NE 68588-0489, USA Phone: (402) 472-3367 Fax: (402) 472-9700 sallgood1@unl.edu	Allgood, Sam	Economics