DP10806 On the Optimal Provision of Social Insurance: Progressive Taxation versus Education Subsidies in General Equilibrium
|Author(s):||Dirk Krueger, Alexander Ludwig|
|Publication Date:||September 2015|
|Keyword(s):||education subsidy, progressive taxation, transitional dynamics|
|JEL(s):||E62, H21, H24|
|Programme Areas:||Public Economics, International Macroeconomics and Finance, Macroeconomics and Growth|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=10806|
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.