How education subsidies can reduce educational participation

In a paper for the Henry tax review on the impact of the tax-transfer system on education and skills, Andrew Leigh concludes:

Contrary to theoretical predictions, I find no significant evidence that more
generous [educational] subsidies or lower tax rates on the rich have the effect of raising educational participation.

The economics of human capital provide the contradicted theories. Human capital economics assumes that the decisions of potential students are sensitive to the private financial benefits of investing in education. If these benefits are made higher, then all other things being equal we will see more people invest in education.

One way of increasing private benefits is to offer subsidies, or more subsidies where they exist already. If part of the cost of education is met by subsidies (mostly from the taxpayer, but also from private philanthropy) lower future private financial benefits will be needed to earn an adequate rate of return on the educational investment. The justification for this is that there are positive ‘externalities’, or spin-off benefits, from having more educated people.

Another way of increasing private benefits is to have low(er) tax rates, so that people who acquire education keep more of its financial benefits. To take an extreme example, if in a highly egalitarian society graduates were taxed 98% of their higher incomes the private benefits of further education would be low, and on the human capital theory we would expect to see low enrolments.

Though all wealthy countries have education subsdies, as I observed in my paper on the Bradley report (pp.12-13), countries with relatively low taxes have high tuition fees by OECD standards, and countries with relatively high taxes have low (often zero) tuition fees by OECD standards.

To greatly over-simplify Andrew L’s analysis, in the OECD which of these policy models is adopted has little obvious effect on tertiary education participation.

One of the difficulties of comparative analysis like this is that it is hard to take into account the many other policy differences between countries. One problem – which is true of Australia – is that we cannot fully infer demand from observed supply. In the absence of coercion in the post-school education demand must be at least at observed supply, but it can, and has been here, higher than supply.

In state-controlled education systems, higher per-student subsidy rates could increase demand but reduce educational participation, because governments deal with their financial constraints by limiting the number of places on offer. HECS was introduced in part to finance an expansion of the higher education system, but despite increased supply demand for HECS places has always exceeded supply, perhaps because the remaining subsidies help make university cheap compared to the average benefits. However governments have been unwilling, until the demand-driven system due in 2012, to let supply meet demand.

Where there are supply constraints imposed by government, low tax rates will also fail to increase educational participation. There may be higher demand for education, but it will convert into ‘unmet demand’ rather than into higher numbers of education places.

Postgraduate coursework places in Australia provide a case study of the negative effects of subsidy and other government interventions on educational participation. Especially in the earlier years of the Howard government, subsidies for many postgraduate coursework places were abolished. On the human capital theory described above, this should have caused enrolments to decrease. Instead, enrolments surged because in the replacement deregulated market there were no supply constraints from government and fees gave universities an incentive to produce more places. To a more limited extent, we saw the same thing when full-fee undergraduate places were allowed in addition to the state-controlled Commonwealth-supported places between 1998 and 2008.

For a country like Australia, if educational particpation is the goal then spreading lower subsidies over a larger number of people will be a more robust policy than Scandinavian-style full subsidies.

6 Responses to “How education subsidies can reduce educational participation

  • 1
    Rajat Sood
    December 9th, 2009 09:24

    Andrew, I think you are absolutely right and it’s a bit of an oversight that Andrew L didn’t consider supply constraints when devising his hypothesis – surely they also apply elsewhere in the OECD? Smearing the aggregate subsidy across a larger number of people would also increase efficiency as well as participation.

  • 2
    derrida derider
    December 9th, 2009 09:55

    That supply constraints exist in other countries does not in itself invalidate Andrew L’s results unless those constraints are correlated with the subsidies. If they’re not correlated at all, or if the correlation has no causal component (ie a common variable drives both), then they’re just another random factor that normal (sic) statistical techniques already account for.

    Education seems to be one of those fields where statistical interpretation is often shoddy. Take this par in today’s Daily Fascist. The researcher and journo clearly think that the fact that low SES students do better than average at uni if they get to go there is a “good news” story. I think it’s prima facie evidence of a problem – that average students from low SES background often don’t get to go to uni (or alternately that bad students from high SES backgrounds do get to go to uni). They’ve clearly never heard of selection bias.

  • 3
    Andrew Norton
    December 9th, 2009 10:19

    DD – I wasn’t saying his theory was wrong, just issuing a warning about its policy implications. Effectively this is that if you go for the high-subsidy route in a country with a lower-tax culture (eg Australia, US, Canada, Japan) the state will struggle with the fiscal demands and constrain supply. In Australia even though supply has been constrained below demand it has still been fairly high by international standards, because partly privately funded. In Scandinavian countries where there is tolerance for very high taxation they have combined zero fees and high participation. But OECD countries with free/very cheap education but public sectors that are fiscally struggling (eg France, Italy, Germany) tend to have lower participation.

    There was a misleading headline on that Oz story, but the story itself was fine. Because of the headline you’ve misread it. It doesn’t say that low SES students do better than average if they go to uni. It says low SES students at Group of Eight unis are more likely to pass and persist than low SES students at other unis. This is not surprising – Group of Eight unis have higher entrance requirements, and prior academic achievement is the main predictor of future academic success.

  • 4
    Tax and Skills « Andrew Leigh
    December 9th, 2009 11:26

    [...] education blogger, Andrew Norton, has written two posts discussing the paper, which can be found here and [...]

  • 5
    Tax and Skills : Core Economics
    December 9th, 2009 11:27

    [...] education blogger, Andrew Norton, has written two posts discussing the paper, which can be found here and [...]

  • 6
    December 9th, 2009 22:57

    What seems strange to me is the assumption of absolute foreknowledge. A degree only has effects a decade later, at minimum, so making assumptions on behaviour based on long term trends seems a little optimistic.

    There is a risk – a significant risk – that by the time you’ve finished the degree and either gotten a certain amount of industrial experience or postgraduate work under your belt that the degree you now have is worthless or nearly so. Conversely a “growth industry” degree also has a good chance of not panning out, either from failure of the sector or reluctance to invest in that area.

    This lag time also has other graphic effects. If the current climate holds very low taxes for high income earners then there is no absolute that that will still be true a decade later. In effect it all comes down to spinning the wheel and playing the averages, which comes down to (on average) a degree will mean greater income over a lifetime and that (on average) greater income will result in a more robust lifestyle. This is in trade however for a significant proportion of time on subsistence level incomes and a later start on career and strong earning years.