Chapter 5 Education

Public Finance and Public Policy Jonathan
CopyrightGruber
© 2010 Fourth
Worth Edition
Publishers
Copyright © 2012 Worth Publishers 1 of 33
Education 11
11.1 Why Should the Government Be Involved in
Education?
11.2 How Is the Government Involved in Education?
11.3 Evidence on Competition in Education Markets
11.4 Measuring the Returns to Education
11.5 The Role of the Government in Higher Education
11.6 Conclusion PREPARED BY
Dan Sacks
Public Finance and Public Policy Jonathan Gruber Fourth Edition Copyright © 2012 Worth Publishers 2 of 33
C HAPTER 11 ■ ED U CATI O N
11
Education
Education is a hotly debated topic in public policy.

• Education is a major part of government spending,
especially state and local spending.
• The United States spends more on education than
most countries…
• …but lags behind leading countries on standardized
test scores.
Education
11.1
Why Should the Government Be Involved in
Education?
There are a number of public benefits (positive

externalities) to education that might justify a
government role in its provision.
• Productivity
o Society can benefit from the higher standard of
living that comes with increased productivity.
• Citizenship
o Education may make citizens more informed and
active voters, improving the quality of the
democratic process.
11.1
Education?
• Educational credit market failure: The failure of the

credit market to make loans that would raise total
social surplus by financing productive education.
o Without public education, many families would
borrow money for their children’s education.
o This market likely would not function well.
11.1
Education?
• Failure to maximize family utility

o Parents may not choose an appropriate level of
education for their children.
• Redistribution
o As long as education is a normal good, higher-
income families would provide more education.
o Income mobility has long been a stated goal for
most democratic societies, and public education
supports this goal.
11.2
Free Public Education and Crowding Out
• Most public education is provided through free public

schools.
• This system may crowd out private education
provision.
o Absent free public schools, some parents would
send their children to expensive, high-quality
schools.
o With free public schools, parents can reduce
quality by a small amount but save a lot.
11.2
Free Public Education and Crowding Out
Other goods
EF
spending
G2 C
A
G1
X
D
G3
Y
G4
Z
E1 EF E2 E3 B Education spending
11.2
Solving the Crowd-Out Problem: Vouchers
One solution to the crowd-out problem is educational

vouchers.
• Educational vouchers: A fixed amount of money given
by the government to families with school-age
children, who can spend it at any type of school, public
or private.
• Vouchers put private schools and public schools on
equal footing.
11.2
Other goods
spending EF
G2 C
A
G1
X1
Y2
G5
Z2
G6
G3
Y1
G4
Z1
E1 EF E2 E4 E3 E5 B Education
EF spending
11.2
Voucher proponents make two arguments for them:

1. Consumer sovereignty
o Vouchers allow individuals to more closely match
their educational choices with their tastes.
2. Competition
o Vouchers allow the education market to benefit
from the competitive pressures that make private
markets function efficiently.
11.2
Problems with Educational Vouchers
Critics make several arguments against vouchers.

• Excess specialization
o By focusing on particular market segments, schools
give less focus to the key elements of education.
• Vouchers will lead to segregation
o Critics of voucher systems argue that vouchers
have the potential to reintroduce segregation
along many dimensions, such as race, income, or
child ability.
11.2
• Vouchers are an inefficient and inequitable use of

public resources
o With vouchers, total public-sector costs would rise,
as the government would pay part of the private
school costs that families currently pay.
• The education market may not be competitive
o The education market is described more closely by
a model of natural monopoly, with efficiency gains
to having only one monopoly provider of the good.
11.2
• The costs of special education

o Special education: Programs to educate disabled
children.
o Each child would be worth a voucher amount that
represents the average cost of educating a child in
that town in that grade, but all children do not cost
the same to educate.
o Students with disabilities cost about twice as much
to educate as students without.
11.3
EVIDENCE: Estimating the Effects of Voucher
Programs
• Direct comparison of voucher users and non-users

misleading.
• Rouse (1998): Oversubscribed schools randomly admit
students.
o Vouchers increased test scores by 1−2 percentage
points.
• Angrist et al. (2002): Columbian vouchers distributed
by lottery.
o Voucher winners 10% more likely to finish 8th
grade, scored higher on standardized tests.
11.3
Experience with Public School Choice
Some school districts have not offered vouchers for

private schools but have instead allowed students to
choose freely among public schools.
• Magnet schools: Special public schools set up to
attract talented students or students interested in a
particular subject or teaching style.
• Charter schools: Schools financed with public funds
that are not usually under the direct supervision of
local school boards or subject to all state regulations
for schools.
11.3
Experience with Public School Incentives
• The United States has implemented many programs

making schools accountable for student performance.
• Accountability encourages schools to increase quality.
• Many states laws, and No Child Left Behind passed in
2001, create accountability measures.
• These laws appear to improve math scores, although
the effect on reading is unclear.
11.3
Experience with Public School Incentives
• Accountability programs have unintended effects:

o They encourage “teaching to the test,” possibly
improving test scores without learning.
o Schools can manipulate the pool of test takers and
the conditions under which they take tests to
maximize success.
o They may encourage schools or teachers to cheat.
11.3
Bottom Line on Vouchers and School Choice
• Evidence is mixed…
• But generally suggests that vouchers improve
educational outcomes.
• They come at the cost of potentially increasing
inequality in educational achievement.
• Some sort of guarantee of access must be provided to
ensure all students have an education.
11.4
Measuring the Returns to Education
Measuring the returns to education is a key, but difficult,

empirical question.
• Returns to education: The benefits that accrue to
society when students get more schooling or when
they get schooling from a higher-quality environment.
• More education clearly leads to higher wages.
• Interpretation of this correlation is controversial.
11.4
Effects of Education Levels on Productivity
There are two main interpretations:

• Education as human capital accumulation
o Human capital: A person’s stock of skills, which
may be increased by further education.
• Education as a screening device
o Screening: A model that suggests that education
provides only a means of separating high- from
low-ability individuals and does not actually
improve skills.
11.4
Effects of Education Levels on Productivity
• Policy implications
o Human capital: Government would want to
support education to raise their productivity.
o Screening: Education does not raise productivity,
so no reason to support it.
• Differentiating the theories
o Most of the returns to education reflect
accumulation of human capital.
o Some screening value to obtaining a high school or
higher education degree.
11.4
EVIDENCE: Estimating the Return to Education
• Comparing wages of people with more and less

education suffers from ability bias.
o More education may reflect intelligence or
motivation, biasing comparison.
• Duflo (2004): Look at school construction, comparing
cohorts and regions with more schools.
• Use laws that force people to stay in school longer.
• Most approaches suggest that each extra year of
schooling increases wages 7−10%.
11.4
Effect of Education Levels on Other Outcomes
Better-educated people…
• Participate more politically
• Perform fewer criminal acts
• Have better health and healthier children
• Have better-educated children
• Have more productive coworkers
11.4
EVIDENCE: Estimating the Effects of School Quality
Some randomized experiments assign students to small

or large classes.
• Project STAR randomly assigned students to small
classes, regular classes, or regular classes with
teacher’s aides.
• Small class size produced test score gains that
persisted well into the future.
• Overall rate of return to small classes: 5.5%.
11.4
EVIDENCE: Estimating the Effects of School Quality
An alternative approach is a quasi-experimental analysis

of changes in school resources:
• Mid 1990s California had the largest class sizes in the
nation, 29 students per class on average.
• The state government in 1996 paid schools to reduce
their class size to 20 students per class.
• Schools that implemented this quickly produced little
gain, relative to schools that took longer.
11.5
Government in Higher Education
• Much of the discussion is on primary and secondary

education.
• In fact about 40% of spending is for higher education.
• Higher education in the United States is viewed as an
enormous success.
• Receives three sources of government financing:
o $234 billion from state and local funding
o $18 billion in Pell grants
o $12.3 billion in tax breaks
11.5
Current Government Role
• State provision
o The primary form of government financing of
higher education is direct provision of higher
education through locally and state-supported
colleges and universities.
• Pell Grants
o The Pell Grant program is a subsidy to higher
education administered by the federal government
that provides grants to low-income families to pay
for their educational expenditures.
11.5
Loans
The federal government also provides support with loans.

• Direct student loans: Loans taken directly from the
Department of Education.
• Guaranteed student loans: Loans taken from private
banks for which the banks are guaranteed repayment
by the government.
• Means-tested subsidies:
o Low interest rate guarantee
o Defer repayment of the loan until graduation
11.5
Tax Relief
• The final way in which the government finances higher

education is through a series of tax breaks for college-
goers and their families.
o Tax credits for families that send their children to
college
o Alternatively, deductions for educational expenses
• These tax breaks add up to about $12 billion per year
in forgone government revenue.
11.5
What Is the Market Failure and How Should It Be
Addressed?
• The major motivation for government intervention in

higher education is not to produce positive
externalities, but rather to correct the failure in the
credit market for student loans.
• Given that the major market failure for higher
education is in credit markets, shifting state resources
away from direct provision and toward loans would
likely improve efficiency.
11.6
Conclusion
• The provision of education, an impure public good, is

one of the most important governmental functions in
the United States and around the world.
• The optimal amount of government intervention in
education markets depends on the extent of market
failures in private provision of education and on the
public returns to education.

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Chapter 5 Education

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Public Finance and Public Policy Jonathan

Education is a hotly debated topic in public policy.

There are a number of public benefits (positive

• Educational credit market failure: The failure of the

• Failure to maximize family utility

• Most public education is provided through free public

One solution to the crowd-out problem is educational

Voucher proponents make two arguments for them:

Critics make several arguments against vouchers.

• Vouchers are an inefficient and inequitable use of

• The costs of special education

• Direct comparison of voucher users and non-users

Some school districts have not offered vouchers for

• The United States has implemented many programs

• Accountability programs have unintended effects:

Measuring the returns to education is a key, but difficult,

There are two main interpretations:

• Comparing wages of people with more and less

Some randomized experiments assign students to small

An alternative approach is a quasi-experimental analysis

• Much of the discussion is on primary and secondary

The federal government also provides support with loans.

• The final way in which the government finances higher

• The major motivation for government intervention in

• The provision of education, an impure public good, is

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