General Equilibrium Cost Benefit Analysis of Education and Tax Policies

67 Pages Posted: 11 Mar 1999 Last revised: 10 May 2000

See all articles by James J. Heckman

James J. Heckman

University of Chicago - Department of Economics; National Bureau of Economic Research (NBER); American Bar Foundation; Institute for the Study of Labor (IZA); CESifo (Center for Economic Studies and Ifo Institute)

Lance Lochner

University of Western Ontario - Department of Economics; National Bureau of Economic Research (NBER)

Christopher Taber

National Bureau of Economic Research (NBER); University of Wisconsin - Madison

Date Written: January 1999

Abstract

This paper formulates and estimates an open-economy overlapping generation general-equilibrium model of endogenous heterogeneous human capital in the form of schooling and on-the-job training. Physical capital accumulation is also analyzed. We use the model to explain rising wage inequality in the past two decades due to skill-biased technical change and to estimate investment responses. We compare an open economy version with a closed economy version. Using our empirically grounded general equilibrium model that explains rising wage inequality, we evaluate two policies often suggested as solutions to the problem of rising wage inequality: (a) tuition subsidies to promote skill formation and (b) tax policies. We establish that conventional partial equilibrium policy evaluation methods widely used in labor economics and public finance give substantially misleading estimates of the impact of national tax and tuition policies on skill formation. Conventional microeconomic methods for estimating the schooling response to tuition overestimate the response by an order of magnitude. Simulations of our model also reveal that move to a flat consumption tax raises capital accumulation and the real wages of all skill groups and barely affects overall measures of income inequality.

Suggested Citation

Heckman, James J. and Lochner, Lance and Taber, Christopher R., General Equilibrium Cost Benefit Analysis of Education and Tax Policies (January 1999). NBER Working Paper No. w6881. Available at SSRN: https://ssrn.com/abstract=147387

James J. Heckman (Contact Author)

University of Chicago - Department of Economics ( email )

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CESifo (Center for Economic Studies and Ifo Institute)

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Lance Lochner

University of Western Ontario - Department of Economics ( email )

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Canada

National Bureau of Economic Research (NBER)

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Christopher R. Taber

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

University of Wisconsin - Madison ( email )

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Madison, WI 53706-1481
United States

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