Human Capital Formation and General Equilibrium Treatment Effects: A Study of Tax and Tuition Policy

Policies to promote human capital formation have been advocated as a remedy for reducing the economy-wide problem of rising wage inequality. These policies are national in character and are designed to substantially alter the proportion of the work-force that is skilled. Yet the methods used to evaluate these policies are partial equilibrium in nature and do not take account of the consequences of the changes in skill prices that are produced by the policies. This paper summarises our research on general equilibrium evaluation of tuition and tax policies. We compare estimates of policy impact from our approach with those obtained from conventional partial equilibrium ‘treatment effect’ approaches to policy evaluation, and find substantial differences. Conventional partial equilibrium approaches present an overly optimistic view of what tax and tuition policy can achieve because they ignore the change in human capital investment levels induced by the change in prices due to the policy. In addition, conventional partial equilibrium approaches fail to provide an accurate assessment of the welfare consequences of these policies. JEL classification: H2, I2. Heckman is in the Department of Economics at the University of Chicago; Lochner is in the Department of Economics at the University of Rochester; Taber is in the Department of Economics at Northwestern