Intergenerational transfer of human capital and optimal income taxation

1This paper has been presented at the CEPR-EPRU workshop “Dynamic As-pects of Public Expenditure”. We would like to thank the participants and partic-ularly our discussant, Ken Smetters, for their helpful comments and suggestions. We are also grateful to David de la Croix for his remarks. This paper studies the design of education policies in a setting of successive generations with heterogeneous individuals (high and low earning ability). Parents ’ investment in education is motivated by warm glow altruism and determines the probability that a child has high ability. Education policies consist of a subsidy on private educational investments and possibly of pub-lic education. We show that when an income tax is available, the subsidy on education should not depend on redistributive considerations. Instead, it is determined by two 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 in-cluded in social welfare (possibility of laundering out). The two terms are of opposite sign and the optimal subsidy may be positive or negative. Finally, we derive conditions under which public education is welfare improving and show that total crowding out of private expenditure (for one of the types) may be desirable.