Risky Higher Education and Subsidies

Abstract

Tertiary education in the U.S. requires large investments that are risky, lumpy, and well-timed. Tertiary education is also heavily subsidized. By making the risk of human capital investment more acceptable, especially to low wealth households, subsidies may increase investment in human capital, lower long-run inequality, and reduce aggregate precautionary savings. However, subsidies also encourage more poorly prepared students to attend and are usually financed via distortionary taxes. In this paper, we find that observed collegiate subsidies improve welfare substantially relative to the fully decentralized (zero subsidy) outcome. We show that subsidies help smooth consumption, lower skill premia, increase interest rates as precautionary savings fall, lower the inequality of both consumption and wealth, increase intergenerational income mobility and raise welfare, even when financed by distortionary taxes.

Keywords: human capital risk, heterogeneous agents, college education

JEL Classification: E60, I22