Public Investment in Human Capital: Insurance Benefit versus Tax Distortions

A part of the current literature on human capital accumulation claims that individuals may prefer to pay taxes that may distort their labor/leisure, and saving/consumption decisions to finance a public education system. Because, this makes it possible for the future members of their family to acquire a certain amount of human capital via public schooling if their parents cannot afford to buy it privately. That is, individuals may consider the insurance benefit of public education outweighing distortionary effects of taxes that raise the required revenue. One of the key assumptions that had been made to prove the above claim in various theoretical models is the following: the only thing that parents can do to increase the lifetime utility of their children is to invest in their human capital. However, it is well known that in real life in addition to that, they leave physical assets as bequests. This assumption makes analytical solution of the theoretical model possible but at the same time it raises doubts about the reliability of results, by possibly overestimating the insurance benefit of public education. This paperÌs objective is to relax this assumption i.e. to find out whether the insurance benefit of public education is large enough to offset the cost of tax distortions in an environment where parents are allowed to leave bequests to their children. Related to that, it aims to understand if insurance benefit is one of the factors that bring about the popular acceptance and support for public education. The last objective is to experiment with different tax/education schemes and compare their effects on physical and human capital accumulation, welfare and distribution. The motivation, here, is to be able to shed some light on the possible effects of different ÏreformÓ proposals for the US public education system. A 2T-period overlapping generations model is employed where the first T period of young generationÌs life and the second T period of the old generationÌs life overlaps. Altruistic parents are allowed to leave physical capital as bequests to their offspring in addition to investment in their education. Agents are assumed to be heterogeneous in ability level. Two types are possible; high and low ability individuals. The type of the offspring is the only source of uncertainty in the model. The model is solved numerically and calibrated to the US data. For different policy experiments steady state physical and human capital, welfare, income and wealth distribution statistics are computed.