Consumption vs. income taxes when private human capital investments are imperfectly observable

This paper considers optimal taxation in an endogenous growth model where p rivate education investments are imperfectly observable. Consumption taxati on is better than labor income taxation for public provision of goods unles s educational investment is completely unobservable. If subsidies are feasi ble for observed education investment, the consumption tax rate is independ ent of the degree of observability but the subsidy rate is higher the lower is the observability. If subsidies are not feasible, the consumption tax r ate is lower the more limited is the observability. Optimal tax rates for g oods that provide consumption and education investment simultaneously are b elow normal rates for observed pure consumption. Growth and welfare are pos itively related to (independent of) the degree of observability without (wi th) subsidies. (C) 2000 Elsevier Science S.A. All rights reserved.