Friday, July 29

The Role of Income Distribution in Financing Human Capital Investment

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By V.K. Chetty & B.K. Pradhan

Working Paper No- 394

We study relations between parents’ income and children’s college graduation, using data for 20.5 million children, born during 1978-83 in the U.S. or authorized immigrants, and their parents, mobility matrices for 741 U.S. commuting zones and Markov chain model for income distribution. Graduation rates are significantly andcausally related to parents’ income shares. In the short run, graduation rate increases when low income share increases for compensated decreases in middle or high income shares. But, in the long run, increase in middle income share compensated by a decrease in low or high income share increases the college graduation rate. In the long run, the middle income class has the dominant effect: a 1% rise in middle income share compensated by a 1% reduction in high income share increases college graduation rate by 0.626%. Impact of low income share is expectedly positive on the high school dropout rate. It falls with a compensated rise in middle or high income share both in the short and long run. Steady state analysis also indicates: (1) economic growth is positively correlated with investment in human (though at a decreasing rate) and social capital; and (2) surprisingly tax progressivity increases economic growth. College graduation rate is negatively associated with fraction foreign born, fraction divorced, fraction black and fraction religious both in short run and in long run. Middle income group is the main driving force, and income distribution and economic growth are intertwined in the determination of investment in human capital. Short-run regressions have causal interpretation for effects of income distribution as data for parents’ and children’s income distributions are separated by as long as 30 years. Directional consistency of steady state and short run results support the hypothesis that effects of parents’ incomes on children’s education are exogenous.

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