Human Capital and Optimal Redistribution

Abstract

We characterize optimal redistribution in a dynastic economy with observable human capital and hidden ability. We show that the wedge between human capital investment in the laissez faire and the social optimum differs from the wedge for bequests because (i) returns to human capital are risky, and (ii) human capital may change informational rents. We compute the optimal allocation when ability is persistent across generations, as calibrated for the U.S. We show how the allocation can be implemented with student loans featuring contingent repayments. The quantitative results reveal that human capital investment should (i) increase in parental income because of ability transmission across generations, but (ii) decrease in inherited assets because of the negative effect of wealth on labor supply. (Copyright: Elsevier)