Should higher education be subsidized more?

Abstract

SUMMARY We investigate in which countries fiscal externalities provide a justification for increasing subsidies to higher education. First, we show that the marginal fiscal recovery rate, i.e., the ratio of the change in total net fiscal revenues and the change in total subsidy costs caused by a small change in tuition subsidies, is the key statistic: if larger than a well-specified threshold value, then a small increase in subsidies is desirable from a welfare point of view. We also show that the marginal fiscal recovery rate depends on three statistics: the elasticity of participation with respect to subsidies, the success probability of the marginal student, and the ratio of the net fiscal revenue gain and the subsidy level of a degree in higher education. Second, we use this formula to approximate the marginal fiscal recovery rate in twenty OECD countries. The average marginal fiscal recovery rate is equal to 0.94, meaning that, on average, 0.94 euro is recovered of an increase in subsidies by one euro. This average hides substantial heterogeneity between countries. In six countries, the marginal fiscal recovery rate is larger than one, implying that an increase in subsidies to higher education is unambiguously desirable (i.e., a Pareto improvement) in these countries. In the other 14 countries, the marginal fiscal recovery rate is below one. Yet, if the degree of inequality aversion is not extreme, then increasing subsidies is also desirable in 12 additional countries. Third, to check the quality of our approximation of the marginal fiscal recovery rate, we simulate it for Belgium (region of Flanders) on the basis of a more detailed model. This simulation provides a somewhat lower, yet fairly similar result compared to the approximation.