The Welfare Cost of Income Taxation and the Role of Human Capital

While the literature on taxes and human capital is extensive, there is little research that focuses on the welfare cost of taxation in the presence of human capital. Moreover, among existing studies we find conflicting implications regarding the welfare cost of taxation. We narrow the gaps and reconcile conflicts among related studies by reexamining the welfare costs of taxation in a standard dynamic model with human capital. Main findings include: (ⅰ) welfare costs increase in general equilibrium in contrast to some existing studies, (ⅱ) compared to typical dynamic models without human capital, those with human capital entail much larger welfare costs of taxation, and (ⅲ) learning-by-doing (LBD) generally adds to welfare costs.