Western University EconomicsWestern Social Science

Human Capital Policy

Human Capital Policy

1. Effective Tax and Subsidy Rates on Human Capital

It is customary to sum up tax disincentives for investment in physical using marginal effective tax rates (ETRs). In a series of papers, Jim Davies and UWO graduate Kirk Collins have analyzed and implemented a comparable ETR for human capital. They have supplemented this with an ESR, or effective subsidy rate, reflecting subsidies to post-secondary institutions as well as student assistance. The ETR and ESR together summarize the tax and expenditure-side incentives for investment in human capital taking into account both the impacts when students are enrolled in college or university and after they graduate. Some key findings are (i) tax progressivity raises the ETR and discourages human capital investment, but that in practice subsidies are strong enough to more than offset this, (ii) ETRs are higher in Canada than in the U.S., and (iii) both ETRs and ESRs have declined in Canada over time.

Related Publications and Working Papers:

Burbidge, John, Kirk Collins, James Davies and Lonnie Magee, "Effective Tax and Subsidy Rates on Human Capital in Canada," Canadian Journal of Economics, 45(1) (2012): 189-219.

Collins, Kirk, and James B. Davies, "Effective Tax and Subsidy Rates on Human Capital Investment via Post-Secondary Education in Canada: 2000 and 2006," prepared for Department of Finance, Government of Canada, April 2007.

Collins, Kirk A., and James B. Davies, "Recent Changes in Effective Tax Rates on PSE Level Human Capital in Canada," in Charles M. Beach, Robin W. Boadway, and R. Marvin McInnis (eds.), Higher Education in Canada, McGill-Queen’s University Press for John Deutsch Institute for the Study of Economic Policy, Queen’s University, Montreal and Kingston, 2005, pp. 417-451.

Collins, Kirk A., and James B. Davies, "Measuring Effective Tax Rates on Human Capital: Methodology and an Application to Canada," in Peter Birch Sorensen (ed.), Measuring the Tax Burden on Capital and Labor, MIT Press, Cambridge, Mass., 2004: 171-212.

Collins, Kirk A., and James B. Davies, "Tax Treatment of Human Capital in Canada and the United States: An Overview and Examination of the Case of University Graduates," in Richard G. Harris (ed.), North American Linkages: Opportunities and Challenges for Canada, The Industry Canada Research Series, University of Calgary Press, Calgary, 2003, pp. 449-86.

2. The Self-Sufficiency Project

The Self-Sufficiency Project (SSP) was a large social experiment in British Columbia and New Brunswick designed to study the effects of providing cash payments for work rather than welfare for individuals on income assistance for an extended period of time. Audra Bowlus, Lance Lochner, Masashi Miyairi, and Chris Robinson use data from the experiment to estimate a lifecycle model in which individuals can improve their wages through human capital accumulation and job search. They then use estimates of their model to explore the effects of changing various parameters of the SSP (e.g. cash payment amount, required period on income assistance to qualify for cash payments).

3. Borrowing Constraints, Family Income, and Post-Secondary Financial Aid Policy

Numerous studies document important gaps in post-secondary attendance by parental income. Economists commonly attribute these differences to the role of borrowing constraints – youth from low-income families may not be able to borrow against high future earnings, so they do not attend college or university even when the long-run payoff may be high. With Western PhD student Philippe Belley, Lance Lochner explores changes in the importance of family income since the early 1980s. With Alexander Monge-Naranjo, Lochner develops a new human capital framework that incorporates key features of existing government student loan programs and private lenders. This model sheds new light on the importance of ability and family income as determinants of post-secondary schooling and helps explain a number of important changes in post-secondary attendance and finance since the early 1980s. Belley, Lochner, and Marc Frenette compare the relative importance of family income as a determinant of post-secondary attendance in Canada and the U.S. and explore the extent to which financial aid policies affect the income – attendance relationship. Using the Berea Panel Survey, Ralph and Todd Stinebrickner show that the attrition of post-secondary students from low income families is largely attributed to reasons other than financial difficulties present during school.

Related Publications and Working Papers:

Belley, Philippe, Marc Frenette, and Lance Lochner, "Post-Secondary Attendance by Parental Income in the U.S. and Canada: Do Financial Aid Policies Explain the Differences?" Canadian Journal of Economics, 47(2), May 2014, 664-696.

Lochner, Lance, and Alexander Monge-Naranjo, "Credit Constraints in Education," Annual Review of Economics, Vol. 4, 2012: 225-256 (also CIBC Working Paper No. 2012-1).

Lochner, Lance, and Alexander Monge-Naranjo, "The Nature of Credit Constraints and Human Capital," American Economic Review, 101(6), October 2011: 2487-2529 (also CIBC Working Paper No. 2010-1).

Stinebrickner, Ralph, and Todd R. Stinbrickner, "The Effect of Credit Constraints on the College Drop-Out Decision: A Direct Approach Using a New Panel Study," American Economic Review, December (2008).

Belley, Philippe, and Lance Lochner, "The Changing Role of Family Income and Ability in Determining Educational Achievement," Journal of Human Capital, 1(1), 2007: 37-89.

Stinebrickner, Ralph and Todd R. Stinebrickner, "Understanding Educational Outcomes of Students from Low-Income Families: Evidence from a Liberal Arts College with a Full Tuition Subsidy Program," Journal of Human Resources, 38(3), Summer 2003, 591-617.

Press References:

"Still Caught in Snare of Poverty in China," Esther Teo, The Straits Times, January 9, 2016.

"A Simple Equation: More Education = More Income," Eduardo Porter, The New York Times, September 10, 2014.

"The Differences Between Low-Income Households in Canada and the U.S.," Reihan Salam, The Agenda (blog), National Review, July 31, 2014.

"College Cost Isn't Poor Students' Big Problem," Christopher Flavelle, BloombergView, July 28, 2014.

"Change Student-Loan System:  Researcher," Chip Martin, The London Free Press, February 11, 2011

"Editorial shorts: Midwest needs bigger share of R&D dollars," StarTribune.com, July 7, 2008.

"Don't just follow the money," Doug Lederman, Inside Higher Ed, August 24, 2007.

4. Immigration and Political Economy

The ability of workers to flow across borders should affect national labor supply elasticities, since mobile workers can leave when the reward from their labor falls. This, in turn, affects the labour supply response to taxes on labour income. James Davies and Stanley Winer consider the implications of severe immigration restrictions to the U.S. introduced in the Immigration Act of 1965 on the political economy of Canada in subsequent years, focusing on the implications for the structure of labour income taxes and the size of the public sector.

Related Publications and Working Papers:

Davies, James B. and Stanley Winer, "Closing the 49th Parallel: An Unexplored Episode in Canadian and Economic History", Canadian Public Policy 37 (2011): 307-334.

5. Efficiency and Equity Effects of Higher Education Policies in General Equilibrium

Elizabeth Caucutt and Krishna Kumar develop a simple dynamic general equilibrium framework to evaluate the consequences of further increasing higher education subsidies for inequality, welfare, and efficiency. This work focuses on three policies. The first is a tax and subsidy scheme that ensures that the parental decision to send a child to college is independent of income. Such a policy decreases the efficiency of the utilization of education resources, while the welfare gain is minimal. The second policy maximizes the fraction of college-educated labor. This results in a large drop in the above-mentioned efficiency with little or no welfare gain. The third is the provision of merit-based aid to the poor as opposed to purely need-based aid. This policy can increase education efficiency with little decrease in welfare. Based on these experiments, Caucutt and Kumar conclude that the case for further increases in higher education subsidies is overstated.

Related Publications and Working Papers:

Caucutt, Elizabeth M. and Krishna B. Kumar, "Higher Education Subsidies and Heterogeneity: A Dynamic Analysis," Journal of Economic Dynamics and Control, 27 (8) 2003: 1459-1502.

6. Tax Policy, Human Capital, and Economic Growth

Understanding the relationship between taxation, skill accumulation and growth is important for policymakers. Elizabeth Caucutt, Selahattin Imrohoroglu, and Krishna Kumar (2006) develop a general equilibrium model of endogenous growth with heterogeneity in income and tax rates in order to study the effect of tax progressivity on economic growth. They show that changes in the progressivity of tax rates can have positive growth effects even in situations where changes in flat rate taxes have no effect. Interestingly, progressive taxation, usually thought of as a policy that reduces inequality, can actually increase the skill premium in the long run and decrease the upward mobility of the poor. Caucutt, Imrohoroglu, and Kumar (2003) investigate these relationships quantitatively by studying a calibrated version of the model. Experiments indicate that the quantitative effects of moving to a flat rate system are economically significant. The assumption made about the engine of growth – an external effect arising from production activities of skilled workers or intentional employment of skilled workers for research and other productivity enhancing activities -- has an important effect on the impact of a change in progressivity. Welfare is unambiguously higher in a flat rate system when comparisons are made across balanced growth equilibria; however, when the costs of transition to the higher growth equilibrium are taken into account, only the currently skilled slightly prefer the flat rate system.

Related Publications and Working Papers:

Caucutt, Elizabeth M., Krishna B. Kumar and Selahattin Imrohoroglu, "Does the Progressivity of Income Taxes Matter for Human Capital and Growth?," Journal of Public Economic Theory, 8(1) 2006: 95-118.

Caucutt, Elizabeth M., Selahattin Imrohoroglu and Krishna B. Kumar, "Growth and Welfare Analysis of Tax Progressivity in a Heterogeneous-Agent Model," Review of Economic Dynamics, 6 (3) 2003: 546-577.

7. Student Loan Repayment

Rising costs of higher education, student debt levels and student loan default rates have heightened tensions within post-secondary student loan programs.  Debts must be repaid by those who can afford it, but there is concern that some low-income borrowers in delinquency and default are financially unable to meet their obligations.  This has prompted calls for expanding repayment assistance and a move to income-contingent repayment schemes.  Using longitudinal data following baccalaureate recipients in the U.S. from 1993 to 2003, Lance Lochner and Alexander Monge-Naranjo study expected losses on loans to different students based on various demographic characteristics, course of study/major, characteristics of the institution they attended, student debt levels, and post-school earnings.  Lance Lochner, Todd Stinebrickner, and Utku Suleymanoglu analyze repayment problems in Canada using unique survey and administrative data from the Canada Student Loans Program.  They find that, in addition to personal income, access to savings and family support are crucial to determining which students have problems repaying their loans.  They further show that efforts to expand income-based repayment schemes to automatically cover all borrowers would lead to dramatic reductions in repayment and program revenue over the first few years of repayment, threatening the sustainability of student lending.

Related Publications and Working Papers:

Lance Lochner and Alexander Monge-Naranjo, "Student Loans and Repayment: Theory, Evidence and Policy," CIBC Working Paper 2014-5.

Lance Lochner and Alexander Monge-Naranjo, "Default and Repayment Among Baccalaureate Degree Earners," CIBC Working Paper 2014-1.

Lance Lochner, Todd Stinebrickner and Utku Suleymanoglu, "The Importance of Financial Resources for Student Loan Repayment," CIBC Working Paper 2013-7.

Lance Lochner, Todd Stinebrickner and Utku Suleymanoglu,"Analysis of the CSLP Student Loan Defaulter Survey and Client Satisfaction Surveys," CIBC Working Paper 2013-3.

Press References:

"Obama's Community-College Gamble," Robert J. Samuelson, The Washington Post, February 4, 2015.

"Will You Be Able to Repay That Student Loan?" Sarah Green, HBR Blog Network, May 21, 2014.

"Western University Experts Highlight Student Debt," John Matisz, Metro, May 20, 2013.

8. Estimating Teacher Quality for Use in Accountability Regimes

The design and introduction of incentive pay schemes for teachers is a linchpin of education policy reform in the U.S. The vast majority of teacher remuneration is based on their experience and credentials, but only a small amount of variation in student achievement is explained by these measures. This has spurred a debate towards introducing incentive pay for teachers. Recently, this debate has moved from theory into actual education policies that affect large numbers of students and teachers, including President Obama's Race to the Top initiative, or the TAP program, which has introduced performance-based bonuses to over 20,000 teachers serving over 200,000 students across the US.

New research by Nirav Mehta compares the performance of two popular estimators of teacher quality that serve as inputs into teacher incentive schemes. By modeling administrators tasked with categorizing teachers using an exogenous cutoff, this research shows that the preferred estimator depends on the relationship between teacher quality and class size. While many researchers and applications have emphasized an Empirical Bayes estimator based on its statistical properties, an analysis of data from Los Angeles shows that the simpler fixed effects estimator outperforms the Empirical Bayes estimator when the objective is to minimize classification errors. Thus, administrators seeking to minimize these errors would prefer to use the fixed effects estimator to either reward high-performing teachers or sanction low-performing ones. Results further suggest that using the preferred estimator in Los Angeles would create 200 fewer teacher classification errors.

Related Publications and Working Papers:

Mehta, Nirav, "Targeting the Wrong Teachers: Estimating Teacher Quality for Use in Accountability Regimes," Working Paper, 2014-3.

9. Why Do Poor Children Perform Poorly?

The economic and social mobility of a generation may be largely determined by the time it enters school given early developing and persistent gaps in child achievement by family income and the importance of adolescent skill levels for educational attainment and lifetime earnings. After providing new evidence of important differences in early child investments by family income, Elizabeth Caucutt, Lance Lochner and Youngmin Park study four leading mechanisms thought to explain these gaps: an intergenerational correlation in ability, a consumption value of investment, information frictions, and credit constraints. In order to better determine which of these mechanisms influence family investments in children, they evaluate the extent to which these mechanisms also explain other important stylized facts related to the marginal returns on investments and the effects of parental income on child investments and skills. Their findings show that to explain the high marginal returns to investment among the poor, information or credit market failures are needed. Absent these market frictions, families will invest until the returns are driven down to or below the returns on savings.  The timing of income is only important (if some parents are constrained in their borrowing. Otherwise, families can always use borrowing and saving to spend money when they want regardless of when it is received. If parents with young children are poorly informed about the value of investments and/or face limited borrowing opportunities, then policies designed to alleviate these market failures can improve economic efficiency while also improving the lives of those who are most disadvantaged.

Related Publications and Working Papers:

Caucutt, Elizabeth, Lance Lochner and Youngmin Park, "Correlation, Consumption, Confusion, or Constraints: Why Do Poor Children Perform So Poorly?" Working Paper, 2015-3.

Press References:

"The "Real Reason Why Poor Kids Perform Worse in School -- And in Life," Elizabeth Caucutt, The Washington Post, April 28, 2015.

"Why Do Poor Children Perform More Poorly Than Rich Ones?" Elizabeth Caucutt, The Conversation, April 23, 2015.