Optimal nonlinear taxation of income and education expenditures

Previous studies that examine the simultaneous setting of income taxation and education policy have overwhelmingly concluded that optimal education policy should be regressive. In this paper, we depart from the existing literature by studying a dynamic model in which the government may choose to impose nonlinear taxes (or subsidies) on both labour income and education expenditures. Our main result is that optimal education policy in our model is progressive. Specifically, if the government can commit to its future tax policy, it is optimal for high-skill individuals to face a zero marginal tax rate on their education expenditures, while that for low-skill individuals is negative. If the government cannot commit, the optimal marginal tax rate on education expenditures by high-skill individuals is positive, while that for low-skill individuals remains negative. Optimal education policy is therefore more progressive when the government cannot commit.