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Title: The Welfare Cost of Income Taxation in the Presence of Human Capital Accumulation: A Sufficient Statistics Approach

Citation Type: Miscellaneous

Publication Year: 2011

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Abstract: The recent literature on the welfare cost of income taxation (e.g., Feldstein, 1999; Chetty, 2008) extends analysis of the scope of distortions from a traditional labor supply distortion to tax avoidance and evasion and debates the importance of tax-sheltering activities.We further extend the scope to include the distortion in human capital investment and show that leaving out human capital investment would understate the true welfare cost of income taxation. Our survey of the related literature and our analysis of the CPS data reveal that theunderestimation of the welfare cost is substantial indeed, with a non-negligible price elasticity of investment in schooling. Our findings, based on a sufficient statistics approach, suggest the following: (i) the long-run welfare cost is larger than existing estimates, at least by more than 60%; and (ii) the share of the distortions arising from overall supply-side behaviors is larger than implied in the existing literature. Another form of skill formation, learning-by-doing (LBD), is found to have similar implications.

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Authors: Lee, Chul-In

Publisher: Seoul National University

Data Collections: IPUMS CPS

Topics: Other

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