Income taxation and finite horizons in a human capital model

We address the issue of capital vs. labor income taxation in an overlapping generations model with a positive externality in the human capital production. We compare the performance of the economy in the steady state under different tax policies. Three results are obtained. First, the size of the tax revenue required strongly affects the optimal (welfare maximizing) capital-labor income tax portfolio. In particular, a zero physical capital income tax rate need not be optimal. Second, the way in which the finite life cycle is split between the working and the retirement period also matters. And third, the size of the externality in the human capital production also affects the optimal income tax rate mix.