When is the Efficient Subsidy to Higher Education the Equitable Subsidy ?

Despite some empirical evidence to the contrary, government subsidy to higher education is usually presumed to be inequitable because college-educated workers earn more than less educated workers. Using a simple model of educational choice with endogenous wages and two worker types, I obtain strong results concerning this conßict between efficiency and equity — namely that equity and efficiency do not conßict unless there are borrowing constraints. Preexisting distorting taxes or real externalities imply that the efficient subsidy is positive and that the efficient subsidy is also the subsidy which maximizes the net income of the unskilled. However, when tuition subsidies are used to overcome borrowing constraints, the efficient subsidy exceeds the subsidy which maximizes the net income of the unskilled. If borrowing constraints could be overcome with another policy, like student loans, efficiency and equity would not be in conßict. In a more complex model with a range of worker abilities there is no equity-efficiency trade-off only when the efficient subsidy is zero — that is, in the absence of real externalities, pre-existing taxes or borrowing constraints. The presence of any one of these three complications makes the efficient subsidy positive, while the subsidy that maximizes the net income of the unskilled is lower. In those cases, efficiency conßicts with equity. ∗Financial support from the Mellon Foundation and the Bankard Fund at the University of Virginia and useful comments by Sarah Turner and Oleksandr Zhylyevskyy are all appreciated.