Are Education Subsidies an Efficient Redistributive Device?

We argue that promoting education may be a means to reduce income equality. When workers of different skill levels are imperfect substitutes in production, an increase in the level of human capital in the economy reduces the return to education and, hence, pre-tax income inequality. The compression of pre-tax wages implies that a given inequality of after-tax incomes can be reached with a less progressive income tax. Optimal redistribution policy faces a trade-off between the distortionary effect of progressive income taxation and the distortions arising from education subsidies. The optimal level of education subsidies crucially depends on the extent to which education compresses the wage distribution, the distortionary effect of progressive income taxation, and the political desire to redistribute income. We discuss empirical evidence showing that the economy's average years of schooling has a strong effect on pre-tax income inequality. We compute for a number of OECD countries the level of education subsidies that could be justified on redistributive grounds. Our argument for education subsidies goes a long way towards explaining the actual pattern and level of education subsidies in OECD countries