Working Paper: NBER ID: w21538
Authors: Dirk Krueger; Alexander Ludwig
Abstract: In this paper we compute the optimal tax and education policy transition in an economy where progressive taxes provide social insurance against idiosyncratic wage risk, but distort the education decision of households. Optimally chosen tertiary education subsidies mitigate these distortions. We highlight the quantitative importance of general equilibrium feedback effects from policies to relative wages of skilled and unskilled workers: subsidizing higher education increases the share of workers with a college degree thereby reducing the college wage premium which has important redistributive benefits. We also argue that a full characterization of the transition path is crucial for policy evaluation. We find that optimal education policies are always characterized by generous tuition subsidies, but the optimal degree of income tax progressivity depends crucially on whether transitional costs of policies are explicitly taken into account and how strongly the college premium responds to policy changes in general equilibrium.
Keywords: social insurance; progressive taxation; education subsidies; general equilibrium
JEL Codes: E62; H21; H24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| education subsidies (H52) | share of college-educated workers (J49) |
| share of college-educated workers (J49) | college wage premium (J31) |
| education subsidies (H52) | college wage premium (J31) |
| optimal education policies (H52) | generous tuition subsidies (I22) |
| degree of income tax progressivity (H29) | transitional costs (P20) |
| transitional dynamics (C69) | welfare losses (D69) |
| education subsidies (H52) | welfare gains (D69) |