Essays in macroeconomics

Abstract

In the U.S., 40% of students drop out of college. While dropout decisions may constitute an efficient response to students' discovering their low academic ability, they may be inefficient if an able student drops out due to adverse financial shocks. In my job market paper, `The Macroeconomic Cost of College Dropouts', I investigate whether the observed dropout rates generate inefficiency by decomposing driving forces behind dropouts. I provide empirical evidence that the probability of dropping out of college is strongly associated with both ability and finances, even after controlling for other factors. I build a quantitative general-equilibrium overlapping generations model, where individuals face incomplete information on their academic ability and uncertainty about the generosity of financial aid. The model simulations show that uncertainty regarding ability is responsible for 20% of the observed dropout rates, while uncertainty regarding financial aid explains up to 53%. Pursuing a policy that eliminates uncertainty about the college aid would increase the social welfare by as much as 2.3%, benefiting both college graduates and non-college graduates. Such a policy is largely self-financing due to endogenous improvements in skill allocation and associated growth in GDP. In my second project, `Education Affordability and Income Inequality' with F.Wang, we address the broad question of what explains the observed income inequality in the U.S. Different tax progressivity schedules are often named as the main factor that drive the difference in income inequality between the continental European countries and the U.S. (see Guvenen, Kuruscu, and Ozkan (2014), Holter (2015)). In this paper, we revisit the role of tax progressivity in shaping earnings inequality, taking into account another aspect that differs across these countries: the price of attaining a bachelor's degree. In the U.S., the price is much higher than in continental European countries. The OECD (2018) reports that the direct cost for students to attain a bachelor's degree constitutes $55000 in the U.S., while in Germany it amounts to $5000. Motivated by this observation, we study the role of education affordability in shaping earnings inequality in the context of an overlapping generations model where agents, heterogeneous in terms of learning ability, initial wealth, and productivity, decide whether to attend college, subject to borrowing constraints. After calibrating the model to the U.S. economy, we perform a number of counterfactual experiments. We find that the Gini coefficient for before-tax wage income would decrease by as much as 16:2 percent if the current education policy, the fraction of higher education costs borne by the U.S. government, were replaced with its German counterpart. On the other hand, we find that labor tax progressivity plays a less significant role in explaining earnings inequality. Besides, poor households with medium and medium-high abilities would benefit the most from this education reform. Apart from distributional gains, the hypothetical policy reform would also boost macroeconomic activities by increasing labor productivity. Finally, analyzing the transitional dynamics shows that every new generation would be better off in terms of utilitarian welfare if the current education policy was replaced with its German counterpart. In my third project, `Larger transfers financed with more progressive taxes? On the optimal design of taxes and transfers', co-authored with Axelle Ferriere, Gaston Navarro, Philipp Gr ubener, we focus on the interplay between the two most important tools governments have at their disposal to reduce inequality - the income tax schedule and targeted transfers. Specifically, we study the optimal joint design of targeted transfers and income taxes. Within a simple heterogeneous-household framework, we derive two analytical results. First, higher transfers reduce the degree of optimal income tax progressivity. Second, optimal transfers are positive under mild conditions on primitives. This is due to both efficiency and redistribution reasons. Large transfers increase the fiscal burden for the government. Lowering marginal tax rates at the top incentivizes labor supply, which helps the government to raise sufficient revenue. Also, having the transfer in place provides some redistribution, reducing the need for higher tax progressivity. We then quantify the optimal tax-and-transfer system in a richer incomplete-market model with a realistic wealth distribution and unemployment risk. The model features novel exible functional forms for progressive income taxes and means-tested transfers. Relative to the current U.S. fiscal system, our preliminary calibration suggests that the optimal policy consists of more generous means-tested transfers, which phase-out at a slower rate, together with less progressive income taxes.