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Does the tax system encourage too much education?

Alstadsæter, Annette
Working paper
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URI
http://hdl.handle.net/11250/162988
Date
2000-07
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  • Discussion papers (SAM) [607]
Abstract
The Nordic countries have dual income taxation, with a proportional tax on capital income

and a progressive tax on labour income. Nielsen and Sørensen (1997) argue that this asymmetric

treatment of the two types of income can be defended on pure efficiency grounds. The

progressivity of the labour income tax serves to reduce the private return to human capital

investment, thereby offsetting the tendency of a proportional comprehensive income tax to

discriminate in favour of such investments. They use a simple overlapping generations model

in a small open economy. The consumer faces a trade-off between investments in financial and

human capital, and education serves only as a means to shift consumption between periods.

The present paper expands this model by including the intrinsic value of education as a motivation

behind getting education. I find that the argument in favour of dual income taxation

is strengthened. A comprehensive proportional income tax works as a tax subsidy on human

capital investments, and it reduces the price of education as a consumption good. This may

explain the puzzle why so many choose to get higher education in the Nordic countries, where

the wage return to education is modest. By introducing a progressive labour income tax, the

total return to education is reduced. Hence the efficiency distortion in the capital market may be partly neutralised.
Publisher
Norwegian School of Economics and Business Administration. Department of Economics
Series
Discussion paper
2000:7

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