Distributional Effects of Public Education in an Economy with Public Pensions

Abstract

We study how the allocation of government expenditures between two major outlays - education and pay-as-you-go social security - affects human capital distribution in an economy with heterogeneous agents. We consider an overlapping generations economy where the government maintains both programs, and allocates tax revenues to finance them. In our model, human capital is one of the factors of production. It is itself produced as a combined result of public inputs and private inputs. Parents' decisions to invest time and material resources in education of their children are motivated by altruism, heterogeneous in its strength across the population, which leads to heterogeneity of incomes. We investigate the effect of an increase in public funding for education on the human capital distribution. We show that in this framework, contrary to some earlier results, increased spending on public education may lead to higher inequality. Our results depend crucially on the interaction of education funding with the social security budget and on the elasticity of substitution in the learning technology.