Tax Progression and Human Capital in a Matching Framework

This paper investigates the effect of tax progression on labour market outcomes in an equilibrium search model with wage bargain and endogenous human capital. We show that this effect depends on whether the firm and the worker can write a binding contract on human capital investments or not. If complete contracts are not possible, either the firm or the worker invests in human capital. We find that the effect of tax progression on human capital depends crucially on which party invests and the tax function that is considered. When the firms invests, we cannot exclude that a higher tax progression increases human capital. Moreover, we find that when a complete contract is possible or when the firms invests, the optimal tax rate in a model with human capital is at least as high as in a model without human capital.