On the Optimal Provision of Social Insurance

SAFE Working Paper No. 110

83 Pages Posted: 26 Jun 2015 Last revised: 17 Nov 2015

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

Goethe University Frankfurt

Date Written: August 29, 2015


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.

Keywords: Progressive Taxation, Education Subsidy, Transitional Dynamics

JEL Classification: E62, H21, H24

Suggested Citation

Krueger, Dirk and Ludwig, Alexander, On the Optimal Provision of Social Insurance (August 29, 2015). SAFE Working Paper No. 110, Available at SSRN: https://ssrn.com/abstract=2623069 or http://dx.doi.org/10.2139/ssrn.2623069

Dirk Krueger

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-6691 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://www.econ.upenn.edu/~dkrueger/

National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

United Kingdom

Alexander Ludwig (Contact Author)

Goethe University Frankfurt ( email )

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Frankfurt am Main, 60323

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