Optimal redistribution when educational background matters

Higher education plays an important role in determining individuals lifetime<br />earnings. In turn, the decision to become educated depends to a large extent on innate ability and on family characteristics, including both family<br />wealth and educational background. In this paper, we abstract from family<br />income differences to concentrate on the effects of fiscal policies on the<br />decision to undertake higher education when the educational background<br />matters. In a dynamic framework, where successive generations are linked by educational background, we consider a government that uses both linear income taxation and a lump-sum subsidy to education. Conditions for<br />optimality of each policy are derived. The factors that determine the sign<br />and magnitude of the tax rate and the subsidy are identified and include<br />concerns for redistribution, efficiency and the educational externality on<br />future generations<br />