Investments in human capital, wage uncertainty, and public policy

The importance of risk characteristics of human capital for the design of tax and education policy is explored. Wages are uncertain and education, while increasing the expected wage, may increase or decrease wage variance. The government has strong reasons to encourage human capital formation in the latter case, partly due to the insurance effect of human capital, and partly due to the way the individuals—under a plausible restriction on ‘prudence’—respond to changes in risk. The analysis is illustrated using two models of education: one where education helps the individuals make better occupational choices, and a standard risk-augmented Becker-type model.