This paper analyzes how integrated labor markets affect the financing of higher education. For this, we employ a general-equilibrium model with overlapping generations and individuals who differ in their abilities. At the first stage, governments can choose the quality of education and the financing system. At the second stage, individuals make their education and migration decisions given the governmental framework for higher education and the mobility assumptions.In a closed economy and in the presence of imperfect credit markets, a mix of tax- and fee-financing is optimal. In integrated labor markets, countries have an incentive to attract skilled workers and to free-ride on education provided by other countries. When only skilled workers are mobile, there is a sub-optimal shift from taxes to fees and the number of students is too low. When also students can migrate, there is a countervailing force such that maintaining the optimal financial mix becomes possible.
