Human Capital, Taxes and Labour Supply

The standard life‐cycle labour supply model accounts for asset accumulation, but ignores human capital investment. This article describes some recent work that introduces human capital into the standard model. This has some interesting, and even surprising, implications for labour supply elasticities. In particular, once we account for the effects of human capital, it appears that labour supply elasticities may be much larger than conventional wisdom would suggest. This, in turn, implies that the efficiency costs of labour income taxation may be much larger than is commonly assumed. Consequently, labour income taxation should be viewed as comparably costly to other types of taxation (such as capital income taxation).