The challenge of a rising skill premium for redistributive taxation

Abstract

The present paper analyzes the challenge to redistribution programs posed by an increase in the skill premium. The skill premium affects both the profitability of education and the profitability of migration. We propose a two country, median voter model, where the equilibrium tax policy is shaped by the desire of the median voter to promote skill formation and to avoid emigration of skilled individuals. Our paper shows that the effect of an increase in the skill premium on redistributive programs depends on the initial level of the skill premium. Below a critical level, an increase in the skill premium is met by an increase in the tax rate. Beyond this level, however, a further rise in the skill premium leads to a fall in the tax rate, and hence a sharp increase in post-tax inequality.