Nate Hilger is on the market from Harvard this year. His job market paper continues a long line of inference that is probably at odds with mainstream political intuition. Roughly, economists generally support cash rather than in-kind transfers because people tend to be the best judges of the optimal use of money they receive; food stamps are not so useful if you really need to pay the heat bill that week. That said, if the goal is to cause some behavior change among the recipient, in-kind transfers can be more beneficial, especially when the cash transfer would go to a family while the in-kind transfer would go to a child or a wife.
Hilger managed to get his hands on the full universe of IRS data. I’m told by my empirically-minded friends that this data is something of a holy grail, with the IRS really limiting who can use the data after Saez proved its usefulness. IRS data is great because of the 1098T: colleges are required to file information about their students’ college attendance so that the government can appropriately dole out aid and tax credits. Even better, firms that fire or layoff workers file a 1099G. Finally, claimed dependents on the individual tax form let us link parents and children. That’s quite a trove of data!
Here’s a question we can answer with it: does low household income lower college attendance, and would income transfers to poor families help reduce the college attendance gap? In a world with perfect credit markets, it shouldn’t matter, since any student could pledge the human capital she would gain as collateral for a college attendance loan. Of course, pledging one’s human capital turns out to be quite difficult. Even if the loans aren’t there, a well-functioning and comprehensive university aid program should insulate the poor from this type of liquidity problem. Now, we know from previous studies that increased financial aid has a pretty big effect on college attendance among the poor and lower middle class. Is this because the aid is helping loosen the family liquidity constraint?
Hilger uses the following trick. Consider a worker who is laid off. This is only a temporary shock, but this paper and others estimate a layoff lowers discounted lifetime earnings by an average of nearly $100,000. So can we just propensity match laid off and employed workers when the child is college age, and see if the income shock lowers attendance? Not so fast. It turns out that matching on whatever observables we have, children whose fathers are laid off when the child is 19 are also much less likely to attend college than children whose fathers are not laid off, even though age 19 would be after the attendance decision is made. Roughly, a father who is ever laid off is correlated with some nonobservables that lower college attendance of children. So let’s compare children whose dads are laid off at 17 to children whose dads are laid off from a similar firm at age 19, matching on all other observables. The IRS data has so many data points that this is actually possible.
What do we learn? First, consumption (in this case, on housing) spending declines roughly in line with the lifetime income hypothesis after the income shock. Second, there is hardly any effect on college attendance and quality: attendance for children whose dads suffer the large income shock falls by half a percentage point. Further, the decline is almost entirely borne by middle class children, not the very poor or the rich: this makes sense since poor students rely very little on parental funding to pay for college, and the rich have enough assets to overcome any liquidity shock. The quality of college chosen also declines after a layoff, but only by a very small amount. That is, the Engel curve for college spending is very flat: families with more income tend to spend roughly similar amounts on college.
Policy-wise, what does this mean? Other authors have estimated that a $1000 increase in annual financial aid increases college enrollment by approximately three percentage points (a particularly strong effect is found among students from impoverished families); the Kalamazoo experiment shows positive feedback loops that many make the efficacy of such aid even higher, since students will exert more effort in high school knowing that college is a realistic financial possibility. Hilger’s paper shows that a $1000 cash grant to poor families will likely improve college attendance by .007 to .04 percentage points depending on whether the layoff is lowering college attendance due to a transitory or a permanent income shock. That is, financial aid is orders of magnitude more useful in raising college attendance than cash transfers, especially among the poor.
November 2012 working paper (No IDEAS version). My old Federal Reserve coworker Christopher Herrington is also on the job market, and has a result suggesting the importance of Hilger’s finding. He computes a DSGE model of lifetime human capital formation, and considers the counterfactual where the US has more equal education funding (that is, schools that centrally funded rather than well-funded in rich areas and poorly-funded in poor areas). Around 15% of eventual earnings inequality – again taking into account many general equilibrium effects – can be explained by the high variance of US education funding. As in Hilger, directly altering the requirement that parents pay for school (either through direct payments at the university level, or by purchasing housing in rich areas at the primary level) can cure a good portion of our growing inequality.