Expected Future Earnings, Taxation, and University Enrollment: A Microeconometric Model with Uncertainty

Abstract

Taxation changes the expectations of prospective university students about their future level and uncertainty of after-tax income. To estimate the impact of taxes on university enrollment, we estimate a structural microeconometric model, in which a high-school graduate decides to enter university studies if expected lifetime utility from this choice is greater than that anticipated from starting to work right away. We estimate the ex-ante future paths of the expectation and variance of after-tax income for German high-school graduates, accounting for nonrandom selection. The enrollment model takes into account university dropout and unemployment risks. Consistently with expectations, the estimation results indicate that higher expected returns to a tertiary education increase the probability of university enrollment, whereas higher uncertainty among graduates decreases enrollment rates. A simulation based on the estimated model indicates that a revenue-neutral, flat-rate tax reform with an unchanged basic tax allowance would increase enrollment rates for men in Germany.