Tax (and Pension) Design in the Presence of Parental Investments

Abstract

We provide a comprehensive theoretical and quantitative evaluation of optimal redistributive policies taking into account parental investments. We build an infinite-horizon Overlapping Generations model in which altruistic parents decide on how much to consume, save, invest in their offspring and the amount of bequests to leave them. We highlight the importance of novel channels that modify the well-known redistribution/efficiency trade-off: we show theoretically that borrowing-constrained parents may be helped by redistribution, but progressive taxation also distorts incentives for human capital investments. We estimate the parameters of the quantitative model and use it to calculate the optimal degree of progressivity. We find that the presence of parental investment calls for lower levels of progressivity than when human capital is exogenous. Joint work with Hakki Yazici.