On the financing of higher education, long run growth, and fiscal deficit

Higher education is a channel through which countries produce and appropriate the necessary knowledge for enhancing productivity. However, its financing is a global challenge for governments. This paper considers the growth, welfare and public deficit implications of the way higher education is financed. We develop a two-sector growth model with a final output sector and a human capital sector, which require physical capital, human capital and public goods to produce output. The novelty is that public spending is financed using a flat income tax, and a user fee levied on private spending on public higher education making it, at least, partially excludable. We find that public spending on tertiary education increases growth, but “free” education is not part of a growthmaximizing policy. Instead, education must be at least partially financed by their receivers. Moreover, our numerical simulations show that a government that seeks growth maximization with a determined policy toward “free” universal higher education and low taxes may face a high déficit and low welfare. That is, the growth benefits do not offset the deficit increase and the welfare loss due to the high rate of education spending. The latter result may be affected if agents derive utility not only from consumption but also from quality leisure, where human capital enhances the utility derived from leisure. This topic is not addressed in the present paper, and would be a posible extension of the original model.