The Great Gatsby Goes to College: Tuition, Inequality and Intergenerational Mobility in the U.S.

Abstract

This paper analyzes the role of the higher education system in shaping income inequality and intergenerational mobility. I introduce a model where overlapping generations of heterogeneous households make college choices subject to a borrowing constraint and with heterogeneous colleges that maximize quality. First, I show that in response to the observed rise in the returns to human capital in the U.S. since 1980, the model predicts an increase in income inequality, tuition, the dispersion of spending per-student across colleges, the exclusion of low-income students from top colleges, and the intergenerational elasticity of earnings (IGE), all consistent with the data. I quantify the model with rich micro-data from the U.S. About 6% of the observed increase in income inequality results from changes in how students and resources are allocated across colleges. Second, I use the model to run policy counterfactuals. If all students received the same higher education, the Gini coefficient and the IGE would decrease by up to 9% and 33%, respectively. Current government interventions—financial aid and transfers to colleges—decrease the Gini coefficient by 3% and the IGE by 12% compared to a laissez-faire benchmark. Need-blind admissions can be particularly useful at increasing mobility and correcting for the misallocation of students and resources, thereby increasing GDP, but also potentially income inequality.