Abstract This paper incorporates labor market inactivity and long‐term unemployment into the framework of optimal redistributive taxation. We examine how a combination of education policy, public employment programs, unemployment benefits, and optimal income taxation can effectively address both redistributive goals and the persistent challenges of long‐term unemployment. Our analysis shows that the second‐best optimal policy typically implies overprovision of education compared with a policy rule that reflects only direct marginal benefits and costs. At the same time, public employment programs and unemployment benefits tend to be underprovided. Using numerical simulations, we illustrate how this policy mix adapts to varying preferences for redistribution, productivity disparities, and the proportion of individuals at risk of long‐term unemployment.
Aronsson et al. (Sun,) studied this question.