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. For that purpose, 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. I provide empirical evidence that the probability of dropping out of college is strongly associated with, both, ability and finances--even after controlling for other factors. The model simulations show ability frictions are responsible for 20% of the observed dropout rates, while financial uncertainty explains up to 53%. Quantitative analysis suggests that pursuing a policy eliminating uncertainty about the college aid would increase social welfare by as much as 2.3% in terms of consumption equivalent variation, benefiting both college graduates and non-college graduates. Such a policy turns out to be to a large extent self-financing due to endogenous improvements in skill allocation and associated growth in GDP.
Presented at: SED 2022 (scheduled), Midwest Macro Meetings 2022 - Utah (scheduled), 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: The U.S. fiscal system redistributes through a rich system of taxes and transfers, the latter accounting for more than half the income perceived by the poorest 20% of households. Motivated by this, we study the optimal joint design of transfers and income taxes. Within a simple heterogeneous-household framework with log-linear income taxes and lump-sum transfers, we derive two analytical results. First, higher transfers reduce the optimal income tax progressivity. Second, optimal transfers are positive. As such, redistribution is achieved with generous transfers while efficiency is preserved via a lower progressivity of income taxes: the optimal tax-and-transfer system features larger progressivity of average than of marginal tax rates. We then quantify the optimal tax-and-transfer system in a richer incomplete-market model with realistic wealth distribution and unemployment risk. The model features a novel flexible functional form for progressive income taxes and means-tested transfers. Relative to the current U.S. fiscal system, the optimal policy consists of more generous means-tested transfers, which phase-out at a slower rate, together with less progressive income taxes.
Presented at: CEPR Paris Symposium (scheduled), 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)