Education policies and optimal taxation

Abstract: This paper studies the design of education policies in a setting in which optimal redistributive labor taxation is available. Households differ in two dimensions: ability and exogenous wealth, both characteristics are not observable. Education is a factor that determines (along with other variables like labor sup-ply, exogenous ability and exogenous income) the consumption possibilities of a household. We study optimal policies consisting of possibly non-linear and linear taxes and direct provision of education under different informational assumptions about education and under different structures of the returns to education. The way labor supply and education are distorted depend, among other things, on the structure of the returns to education. It is particularly interesting that ed-ucation policy is not always marginally elitist. Allowing for both negative and positive marginal tax rates on labor income the paper also studies the interaction of taxation of labor income and of education