| Abstract: | We use a simple two‐period equilibrium framework to explore the effects of two different subsidization regimes for higher education on the formation of human capital and on the distribution of incomes. Individuals finance their investments in higher education through income‐contingent education loans as well as subsidies from the government. The subsidy is tax‐financed. We compare an egalitarian subsidy scheme, which reduces by a uniform amount the tuition charged to students, with a student loan subsidy which is proportional to the student's debt service obligation. We show that both types of subsidies reduce the economy‐wide underinvestment in higher education and lead to a more equal income distribution. Furthermore, according to some social welfare criterion, the student loan subsidy regime dominates the tuition subsidy regime if the subsidy level is predetermined, while the converse is true if the subsidy level constitutes a choice variable of the government. |
