Government Expenditure on Education

Chao Fu, John Kennan and Shoya Ishimaru
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Chao Fu: University of Wisconsin - Madison

No 802, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: Research on education has long acknowledged that it is a cumulative process, where later achievements depend heavily on investments made in the past. However, most education policy discussions have been focused on one particular educational stage. The paper develops and estimates a model that can be used to analyze the interactions between policies affecting education at different stages. For example, policies designed to make college more accessible, particularly for disadvantaged groups, should be evaluated in the context of the educational system as a whole. If disadvantaged households increase investment in their children's pre-college education in expectation of easier college access, the impact of such policies can be enhanced. But if the quality of pre-college education does not improve, improved access to college may be of very limited benefit, due to the cumulative nature of human capital development. Moreover, as the government invests more in college education, there may be fewer resources available for lower level education. In order to predict the impact of alternative policy interventions, the paper tracks the decisions of households and governments in an equilibrium framework that is designed to be consistent with observed outcomes in U.S. data. In the model, educational outcomes depend on student characteristics (including past achievement) and monetary inputs, i.e., tuition in the private sector and per-student government expenditure in the public sector, via technologies that may differ across the two sectors. Players in the model include a government and heterogenous households. The government maximizes a weighted average of household welfare by choosing the tax rate, per-student expenditure levels on public K-12 and college education, college tuition and the provision of other public good, subject to a balanced-budget constraint. Households care about consumption, their children's human capital (education achievement) and the burden of college loans. Taken as given the government's decision, households make dynamic choices between private and public K-12 schools, then between the options of no college, two-year colleges, four-year public colleges and four-year private colleges and how much college loans to take. Realizing that its decisions would lead to different equilibrium outcomes, the government chooses the policy to optimize its objective.

Date: 2018
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