Macrodynamic Implications of Income-Transfer Policies for Human Capital Investment and School Effort

The distortion in educational investment in poorer children is often attributed to credit market imperfections and hence to the unequal access of children to educational opportunity. However, the distortion might also be attributable to disincentive effects that cause children to make inefficient use of educational opportunities. This possibility is demonstrated for an overlapping generations economy with multiple family dynasties in which children have random unobservable abilities and base their school effort on their parents’ after-tax returns to schooling. Income redistribution can result in suboptimal effort choices that offset the beneficial effects of income transfers and sharply lower social welfare.