Optimal Financial Aid Policies for Students
Dominik Sachs and
No 1421, 2016 Meeting Papers from Society for Economic Dynamics
We study the optimal design of financial aid policies for college students. The total social benefits of college education exceed the private benefits because the government receives a share of the monetary returns in the form of income taxes. We underscore the policy implications of this fiscal externality in an optimal dynamic public finance framework. The model incorporates multidimensional heterogeneity, idiosyncratic risk and borrowing constraints. It matches key empirical results on college enrollment patterns, returns to education and enrollment elasticities. We find that a marginal increase in college subsidies in the US is at least 70 percent self-financing through the net-present value increase in future tax revenue. When targeting this increase to children in the lowest parental income tercile, it is more than self-financing with a fiscal return of 165 percent. The optimal Mirrleesian income tax schedule is barely affected, in particular if subsidies are set at their optimal level.
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