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We study a life-cycle model with heterogeneous agents of discrete skill types. In the model, unobservable skills evolve over time through endogenous human capital investment, rather than via stochastic shocks. Our main findings are as follows. First, even though our model has no uncertainty and thus no insurance motive, the capital wedge is positive. Next, the labor wedge is neither always positive nor constant over time, but is negative in first period and ambiguous before the terminal period of the life cycle. Finally, these wedges can be implemented as linear taxes on capital and labor, along with lump-sum taxes, in the competitive market and there is a welfare gain from the second-best optimal mechanism, with the gain increasing in the gap of agents' skills
