Abstract

Catalyzers for Social Insurance: Education Subsidies vs. Real Capital Taxation We set up a two-period model, where individuals finance educational investment and first-period consumption by borrowing against risky second-period labor income. We show that the government should use both education subsidies and capital taxation to mitigate distortions, stemming from social insurance through labor taxation, and we derive a Ramsey-rule for the optimal combination of these instruments. Relative to capital taxation, optimal education subsidies increase in their relative effectiveness to boost labor and in individuals ’ underinvestment into education, but they decrease in their relative net distortions. For their absolute levels, indirect complementarity effects, i.e., influencing the effectiveness of the other instrument, do matter. Generally, a decrease in capital taxes should go along with an increase in education subsidies. We also show that, even under uncertainty, the optimal capital tax rate can be zero, if education