The Macroeconomic Cost of College Dropout
Abstract: More than 40% of US college students drop out without gaining a degree. This paper investigates whether dropouts are largely due to academic ability or financial constraints. Empirically, I document three facts. First, even after controlling for ability, poor students have a higher ex-ante probability of dropping out; second, a large fraction of eligible students lose grants; and third, losing grants reduces students' graduation probabilities. Based on these findings, I build a quantitative general-equilibrium overlapping generations model, where individuals face incomplete information on their academic ability and uncertainty about the generosity of financial aid. The model simulations show that uncertainty regarding ability is responsible for 10% of the observed dropout rates, while uncertainty regarding financial aid explains up to 43% of the dropout rates. The residual dropout rates are attributed to labor market opportunities. Pursuing a policy that eliminates uncertainty about college aid would increase social welfare by as much as 2.4%, benefiting both college graduates and non-college graduates. The increase comes from lower skill premiums, higher aggregate productivity, and reduced uncertainty at the beginning of the life cycle when insurance is the most expensive. Such a policy is self-financing mainly due to endogenous improvements in skill allocation and associated growth in GDP.
Presented at: SEA 2022 Fort Lauderdale, SITE 2022 Stanford, SED 2022 Madison, Midwest Macro Meetings 2022 - Utah, Yale University, EEA-ESEM 2021, Barcelona GSE Summer Forum 2021, VMACS Junior Conference, Atlanta FED, University of Munich, University of Helsinki, ES World Congress 2020, Winter Meetings of Econometric Society 2019 (Rotterdam), University of Bristol, University of Konstanz, XXIV workshop on dynamic macroeconomics (Vigo), European University Institute (Florence)
with Fuzhen Wang
Abstract: We study the role of education affordability in shaping earnings inequality in the context of an overlapping generations model where agents, heterogeneous in terms of learning ability, initial wealth, and productivity, decide whether to attend college, subject to borrowing constraints. After calibrating the model to the US economy, we perform a number of counterfactual experiments. We find that the Gini coefficient for before-tax wage income would decrease by as much of 16.2 percent if the current education policy, the fraction of higher education costs borne by the government, were replaced with its German counterpart. Poor households with medium and medium-high ability would benefit the most from it. Apart from distributional gains, the hypothetical policy reform would also boost macroeconomic activities by increasing labor productivity. In contrast with the existing literature, we find that labor tax progressivity plays a less significant role in explaining earnings inequality. Finally, transitional dynamics show that every new generation would be better off in terms of utilitarian welfare if the current education policy were replaced by its German counterpart.
Presented at: SED meetings Minnesota 2021, European Meeting of the Econometric Society (Manchester), The ECINEQ Meeting 2019 (Paris), Midwest Macroeconomics Meetings 2019 (Athens), European Winter Meeting of the Econometric Society 2018 (Naples), Midwest Macroeconomics Meeting 2018 (Madison), University of Wisconsin (Madison), University of Konstanz, European University Institute (Florence)
Abstract: We study the optimal design of means-tested transfers and progressive income taxes. In a simple analytical model, we show that adding a transfer to a log-linear tax induces welfare gains almost as large as in the second-best allocation. Transfers allow for more progressive average than marginal tax-and-transfer rates, achieving redistribution while preserving efficiency. In a rich dynamic model, we quantify the optimal fiscal plan. We use new flexible functions featuring targeted transfers and progressive income taxes, delivering a good empirical fit across the income distribution. Transfers should be larger than currently in the U.S. and financed with moderate income-tax progressivity.
Presented at: CEPR Paris Symposium 2022, NBER Summer Institute 2021, SED meetings Minnesota 2021, IIPF Annual Congress 2019, Barcelona GSE Summer Forum 2020, ES World Congress 2020, Danmarks Nationalbank, EEA Annual Congress 2020, Verein für Socialpolitik (German Economic Association) Annual Congress 2020, European University Institute (Florence)