On the importance of fertility behavior in school finance policy design

To design an optimal education policy, it is essential to account for the fertility differential between the poor and the rich because it affects the human capital investment through the child quantity-quality tradeoff of children. We develop a dynamic general equilibrium in which parents choose the quantity of children, transfer a preschool ability to their children, determine the quality of children by choosing private expenditures on basic education in addition to public expenditures on basic education, leave a bequest that could be used to finance college education. Moreover, there is an uncertainty in college completion depending on ability and endogenous wage determination based on the amount of schooling in the economy. It is very important to consider general equilibrium effects because the change in either fertility behavior or college outcomes as a result of policy changes leads to a large change in aggregate skill distribution. We find that ignoring fertility behavior, especially differential fertility substantially underestimates the role of credit constraints in the economy. We also analyze the impact of basic education subsidies and college subsidies on welfare, inequality, and intergenerational mobility. Strikingly, the choice between these two policies is found to be dependent on the magnitude of differential fertility rate.