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Optimal human capital policies under the endogenous choice of educational types

This study examines optimal human capital policies under non-linear labor and capital income taxes in the presence of consumption value of education in a two-period setting. We show that when individuals can choose educational types differing by the relative importance of consumption value and production value, education subsidies for low-type individuals should not equal an efficient level that offsets distortions induced by non-linear taxes on labor and capital income. Our findings imply that education policy does not restore efficiency, or the Diamond-Mirrlees production efficiency theorem fails. Moreover, capital income taxation is optimal, which means that the Atkinson-Stiglitz theorem breaks down.