Scandinavian Working Papers in Economics

Working Paper Series,
Research Institute of Industrial Economics

No 1413: Optimal Redistribution in the Presence of Signaling

Spencer Bastani (), Tomer Blumkin () and Luca Micheletto ()
Additional contact information
Spencer Bastani: Institute for Evaluation of Labour Market and Education Policy (IFAU), Uppsala, Postal: and Research Institute of Industrial Economics (IFN), Stockholm, Sweden, UCFS, UCLS, CESifo, Germany
Tomer Blumkin: Department of Economics, Ben Gurion University, Postal: CESifo, Germany; IZA
Luca Micheletto: Department of Law, University of Milan, and Dondena Centre for Research on Social Dynamics and Public Policy, Bocconi University; UCFS; CESifo, Germany

Abstract: We analyze optimal redistribution in the presence of labor market signaling where innate productive ability is not only unobserved by the government, but also by prospective employers. Our model features signaling in both one and two dimensions, where in the latter case firms have an informational advantage vis-a-vis the government. Focusing on signals in the context of educational attainment, we analyze the dual role of income taxation in redistributing income and affecting signaling incentives as well as the role of extended tax systems that combine income taxation with direct taxes on the signals in the form of education taxes/subsidies. We demonstrate how the government can achieve redistribution through wage compression and analyze the conditions under which such redistribution is feasible and socially desirable.

Keywords: Nonlinear taxation; Education; Asymmetric information; Human capital

JEL-codes: D82; H21; H52; J31

50 pages, November 1, 2021

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