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In this paper we study the optimal policy in the Uzawa–Lucas model with externality in human capital when agents value both consumption and leisure. We find that the government pursuing the first best can achieve its goal by a subsidy which depends on foregone earnings while studying and which is financed through a lump sum tax. Anyway, the optimal policy, that should be designed to provide incentives for agents to devote more time to schooling and cut both on leisure and working, is not unique. There exists an infinite number of combinations of consumption, capital income, labor income and lump sum taxes that can decentralize the first best.

Optimal taxation in the Uzawa–Lucas model with externality in human capital