Optimal Tax and Education Policy When Agents Differ in Altruism and Productivity

This paper studies the design of education policies in a setting of overlapping generations with heterogeneous individuals. Individuals differ in productivity (high and low earning ability) and in altruism (altruists and non altruists). Only altruistic parents invest in education out of some joy of giving. Their investment determines the probability that a child has high ability. Education policies consist of a subsidy on private educational investments and of public education. We show that when an income tax is available, the subsidy on education should not depend on redistribution. Instead, it is determined by the following terms. First, a Pigouvian term which arises because under warm glow altruism parents¡¯ utility does not properly account for the impact of education on future generations. The second term captures a ¡°merit good¡± effect, which arises when the warm glow term is not fully included in social welfare (possibility of laundering out). Third, depending on the information structure there may be a substitution term that arises because the demand for second period consumption and for education transfer are interdependent. The first two terms are of opposite sign and the optimal subsidy may be positive or negative. Finally, we derive conditions under which public education is desirable. Public education affects also the probability of being highly productive for the altruists and the non altruists. Its desirability will in part depend on its substitutability with private educational investment.