Still Thinking about Mark Kleiman's post on Education.
Click the link and read itProf. Kleiman says he doesn't know if enrollment in Universities is too high or too low. There are arguments both ways. I argue it is too low below. I admit my evidence is weak so I want to argue in the alternative about what should be done in either case.
The regular reader will not be surprised by my policy conclusions (hint: I always want to soak the rich).
One point is clear from micro data. The private returns to higher education are very high compared to private returns to financial investments "the real rate of return on educational investment (including the opportunity cost of forgone wages) seems to run somewhere between 7% and 10% per annum, which is a healthy rate of return. (Capital-market imperfections help explain this: it's hard for most people to borrow against the future stream of earnings from the human capital they'd like to acquire.)"
Assuming that social returns are equal to private returns, this means that even greater subsidies to education would cause increased GNP. That is, if the only deviations from economics 101 are the capital market imperfections, the policy implication is for the taxpayer to bear an even larger fraction of the cost of schooling.
But maybe sending more people to university is not a good investment for the nation, because they are there to signal and not to learn useful skills. If this is so, a standard argument against progressive taxation -- that it discourages human capital investment -- is reversed. If the quest for high salaries involves waste due to dissipative signaling, redistribution from rich to poor via taxes and transfers can increase economic efficiency. It is easy to write simple models in which such policies cause a Pareto improvement.* If the problem were too high university enrollment, the solution would be to tax high income workers and give the money to people who do not go to university (this could be done with an expanded EITC financed by taxing high incomes).
In contrast, if university enrollment is too low one could cut taxes on high incomes or give cash directly to people who enroll (via increased subsidies). The fact that the return to going to university is much higher than the t-bill rate implies that increased subsidies are a more efficient way to increase enrollment. The present value (to the treasury) of a direct subsidy with equal effect on enrollment as a tax cut is lower, since prospective students discount at a higher rate than the treasury.
Of course another way to achieve efficiency if too many go to university is to cut subsidies raise tuition and use the money for the EITC but the efficiency argument for subsidies as opposed to tax cuts works the other way here as one is pushing the other way here. The USA can achieve the same goal with a big tax increase or a small tuition increase and the big tax increase is better for the deficit.
So I conclude that whatever Kleiman concludes on university enrollment he ought to support soaking the rich either to expand the EITC or to increase public subsidies to universities. In each case the justification has nothing to do with egalitarianism as each policy can increase money metric welfare.
