The Economics of Financing Higher Education

Different arguments exist pro and contra tax-financed subsidies in higher education. It has been argued that private incentives to study are sufficiently high, while the financing of those subsidies can be deemed regressive as they are co-financed by relatively poorer non-students. Alternatively, several arguments have been put forward why (higher) tax-financed subsidies are desirable, such as externalities and credit constraints. This study scrutinizes these different arguments and discusses the implications for the different ways in which higher education can be financed. Calculations of private returns across the OECD confirm that private incentives to invest in higher education are high. However, economic theory poses that it is the marginal social return that must guide policy, which will reflect both equity and efficiency considerations. We assess the potential regressivity of higher education subsidies using different perspectives, and assess the different efficiency arguments for government intervention in higher education. Tax-financed subsidies turn out to be regressive in most cases, but depending on the perspective and the country under examination. Discussion of the efficiency arguments is focused on those that are most relevant in light of the empirical evidence and their relevance for the different financing modes: externalities, uninsurable risk, credit constraints, and misprediction. We conclude that, to deal with the more credible failures in higher education, tax-financed subsidies are blunt instruments. For a large share of the countries under consideration, shifting towards income-contingent loans or graduate taxes appears more appropriate when taking into account both efficiency and equity considerations.