Working Paper: CEPR ID: DP9505
Authors: Robert Garybobo; Alain Trannoy
Abstract: We completely characterize the set of second-best optimal "menus" of student-loan contracts in a simple economy with risky labour-market outcomes, adverse selection, moral hazard and risk aversion. The model combines structured student loans and an elementary optimal income-tax problem à la Mirrlees. This combination can be called a graduate tax. There are two categories of second-best optima: the equal treatment and the separating allocations. The equal treatment case is obtained when the social weights of student types are close to their population frequencies; the expected utilities of different types are then equalized, conditional on the event of success on the labor market. But individuals are ex ante unequal because of differing probabilities of success, and ex post unequal, because the income tax trades off incentives and insurance (redistribution). In separating optima, the talented types bear more risk than the less-talented ones; they arise only if the social weight of the talented types is sufficiently high. The second-best optimal graduate tax provides incomplete insurance because of moral hazard; it typically involves cross-subsidies; generically, it cannot be decomposed as the sum of an optimal income tax depending only on earnings, and a loan repayment, depending only on education. Therefore, optimal loan repayments must be income-contingent.
Keywords: student loans; optimal taxation; asymmetric information; mechanism design; higher education
JEL Codes: D82; I22; I24; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| student loan structures (G51) | labor market outcomes (J48) |
| graduate tax (H29) | labor market outcomes (J48) |
| design of loan contracts (G51) | expected utilities of different student types (D11) |
| social weight of talented types (Z13) | risk exposure of talented students (D29) |
| structure of loans (G21) | risk allocation (G22) |
| second-best optimal graduate tax cannot be decomposed into optimal income tax and loan repayment (H21) | labor market outcomes (J48) |