In his Henry tax review paper, Andrew Leigh says:
The principle that education subsidies should be increased (or graduate taxes decreased) if there is a social return to education fails to hold only in very special circumstances.
These ‘special circumstances’ are that
1. Subsidies or taxes would be ineffective, i.e. would not increase educational attainment.
2. Everyone is already getting the maximum level of education.
3. Lumpy investments, e.g. where the optimal level might be 1 year of post-compulsory education but only 3-year degrees can be purchased.
But is circumstance 1 really so ‘special’? As noted in an earlier post Andrew’s empirical evidence suggests that circumstance 1 may common rather than special.
The starting point for an argument that circumstance 1 is common is that in many disciplines private returns are at a level that encourages private educational investment, and so there is no need to offer any additional incentives. Subsidies pay people to do what they would do anyway.
Andrew’s earnings data on graduates versus people with year 12 education (p.34 of his paper) shows that graduates have a considerable earnings premium. This premium is an average, for most graduates it is higher because the average is deflated by the quarter or so of people with university qualifications working in less-skilled occupations.
I also think that earnings data tends to under-state the private benefits of education. If we look at what people want in jobs, it’s not just money. Indeed, apart from hoping for the more ‘interesting’ work that education may open up, people already incorporate ‘social returns’ into their private calculations in wanting jobs that help people or contribute to society (there are private psychological rewards in feeling that you make a social contribution).
Education is also a consumption good. Many people give as reasons for attending university things unrelated to future financial benefits, and even those who are primarily motivated by vocational concerns would often place some value on the experience of education aside from generating a qualification.
So we have reasons for supposing that there would be considerable educational participation, and associated social returns, with no subsidies at all.
Under human capital theory, subsidies would influence those who calculate that their private returns are too low to justify investment. However, one possibility is that they mis-calculate those private returns and that a cheaper strategy would be to persuade them to think again rather than to offer them a handout.
But what if they have correctly calculated that the private returns are too low? In this case, the most reliable ‘social return’ – higher tax revenues – will not eventuate or be small. We therefore need to determine whether the remaing social returns of subsidies exceed the social costs of subsidies. After all, there is an opportunity cost with every subsidy dollar, and a large opportunity cost if (as under current policy settings) subsidies aimed at the marginal would-be student are paid to all students.
The trouble with assessing these costs and benefits is that the benefits as described by Andrew – better health, better family outcomes, less crime, productivity spillovers, increased social and political engagement – sometimes have limited evidence and unclear causal mechanisms (and may justify school but not university subsidies).
So I’m really not sure that the social returns argument gets us very far in theory, and Andrew L’s finding that subsidies don’t reliably lead to higher participation suggests that this scepticism is consistent with the empirical evidence.