Equity vs. Effi ciency in Subsidies to Higher Education

Despite some empirical evidence to the contrary, government subsidies to higher education are 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 conflict between effi ciency and equity —namely that equity and effi ciency do not conflict unless there are borrowing constraints. Preexisting distorting taxes or real externalities imply that the effi cient subsidy is positive and that the effi cient subsidy is also the subsidy which maximizes the net income of the unskilled. However, when tuition subsidies are used to overcome borrowing constraints, the effi cient subsidy exceeds the subsidy which maximizes the net income of the unskilled. If borrowing constraints could be overcome with another policy, like student loans, effi ciency and equity would not be in conflict. In a more complex model with a range of worker abilities there is no equity-effi ciency trade-off only when the effi cient 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 effi cient subsidy positive, while the subsidy that maximizes the net income of the unskilled is lower. In those cases, effi ciency conflicts 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.