Optimal progressive taxation in a model with endogenous skill supply

This paper examines quantitatively the extent of progressivity or regressivity of optimal labour income taxation in a model with skill heterogeneity, endogenous skill acquisition and a production sector with capital-skill complementarity. We Â…find that wage inequality driven by the resource requirements of skill-creation implies progressive labour income taxation in the steady-state as well as along the transition path from the exogenous to optimal policy steady-state. In particular, in the steady state, skilled labour income is taxed about 40% more than unskilled labour income. We further Â…nd that these results are explained by a lower work time elasticity for skilled versus unskilled labour which results from the introduction of the skill acquisition technology.