Dynamics of Output Growth, Consumption and Physical Capital in Two-Sector Models of Endogenous Growth

This paper examines a two-period model of optimal nonlinear income taxation with learning-by-doing, in which second-period wages are an increasing function of rst-period labour supply. We consider the cases when the government can and cannot commit to its second-period tax policy. In both cases, the canonical Mirrlees/Stiglitz results regarding optimal marginal tax rates no longer apply. In particular, if the government cannot commit and skill-type information is revealed, it is optimal to distort the high-skill consumers labour supply downwards through a positive marginal tax rate to relax the incentive-compatibility constraint. Alter-natively, if the government cannot commit and skill-type information is concealed, it is optimal to distort the high-skill consumers labour supply upwards to relax the incentive-compatibility constraint, but due to some other factors at work the high-skill consumers marginal tax rate cannot be signed. Our analysis therefore identi es a setting in which a positive marginal tax rate on the highest-skill indi-vidual can be justi\u85ed, despite its depressing e¤ect on labour supply and wages