On the Optimal Provision of Social Insurance: Progressive Taxation Versus Education Subsidies in General Equilibrium

81 Pages Posted: 8 Sep 2015 Last revised: 8 May 2023

See all articles by Dirk Krueger

Dirk Krueger

University of Pennsylvania - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Alexander Ludwig

Max Planck Society for the Advancement of the Sciences - Munich Center for the Economics of Aging (MEA); Goethe University Frankfurt

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Date Written: September 2015

Abstract

In this paper we compute the optimal tax and education policy transition in an economy where progressive taxes provide social insurance against idiosyncratic wage risk, but distort the education decision of households. Optimally chosen tertiary education subsidies mitigate these distortions. We highlight the quantitative importance of general equilibrium feedback effects from policies to relative wages of skilled and unskilled workers: subsidizing higher education increases the share of workers with a college degree thereby reducing the college wage premium which has important redistributive benefits. We also argue that a full characterization of the transition path is crucial for policy evaluation. We find that optimal education policies are always characterized by generous tuition subsidies, but the optimal degree of income tax progressivity depends crucially on whether transitional costs of policies are explicitly taken into account and how strongly the college premium responds to policy changes in general equilibrium.

Suggested Citation

Krueger, Dirk and Ludwig, Alexander, On the Optimal Provision of Social Insurance: Progressive Taxation Versus Education Subsidies in General Equilibrium (September 2015). NBER Working Paper No. w21538, Available at SSRN: https://ssrn.com/abstract=2656940

Dirk Krueger (Contact Author)

University of Pennsylvania - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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Alexander Ludwig

Max Planck Society for the Advancement of the Sciences - Munich Center for the Economics of Aging (MEA) ( email )

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Germany

Goethe University Frankfurt ( email )

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Germany

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