Taxation and Human Capital Accumulation

How do taxes affect human capital accumulation? This question has been studied extensively in the context of two model classes: overlapping generations (OLG) and infinite horizon (IH) models. These embody very different assumptions about the intergenerational transmission of physical and human capital. OLG models typically abstract from intergenerational linkages, while IH models implicitly assume that new agents inherit human and physical capital from their parents. This paper investigates how such differences in intercohort persistence affect the responsiveness of human capital to taxation. A model is developed that nests OLG and IH models as special cases. The steady state and transitional effects of tax changes are computed for varying degrees of persistence. The main finding is that stronger intercohort persistence magnifies the long-run impact of taxation on human capital and leads to slower transitional dynamics. As a result, IH models generate systematically larger tax effects than OLG models, even if generations are altruistically linked. For the tax experiments studied here, the impact of persistence is large. Models with complete persistence generate steady state tax elasticities at least two times larger and transitional half-lives at least three times longer than do models without persistence. JEL: E62, J24, O41.