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Essays in fiscal federalism [Elektronische Ressource] : welfare competition and the funding of higher education / vorgelegt von Malte Hübner

177 pages
Essays in Fiscal Federalism- Welfare Competition and theFunding of Higher Education-Inauguraldissertationzur Erlangung des akademischen Gradeseines Doktors der Wirtschaftswissenschaftender Universit¨at Mannheimvorgelegt vonMalte Hu¨bnerJuni 2009Abteilungssprecher: Prof. Tom Krebs, PhDReferent: Prof. Dr. Eckhard JanebaKorreferent: Prof. Dr. Robert SchwagerTag der Verteidigung: Freitag, 20. November 2009AcknowledgementsFirst of all, I would like to thank my supervisor Eckhard Janeba for giving me the op-portunity towork onthetopicspresented inthisthesis. Ialso appreciated hisinvaluableguidance, instructive feedback and the great research environment at his chair.This thesis has also benefitted a lot from helpful discussions with participants in thepriority program ”Institutional Design of Federal Systems” of the German ResearchFoundation (DFG).I am grateful to Robert Schwager for many helpful comments and discussions duringvarious workshops and for acting as a referee on my thesis committee.During the time at the Chair of Public Finance I enjoyed working with my colleaguesJennifer Abel-Koch, Nicole Borheier and Bj¨orn Sass and appreciated very much thefriendly atmosphere and the numerous constructive comments.In the past five years I have also received a lot of support from my colleagues at theCenter for Doctoral Studies in Economics (CDSE) at the University of Mannheim.
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Essays in Fiscal Federalism
- Welfare Competition and the
Funding of Higher Education-
Inauguraldissertation
zur Erlangung des akademischen Grades
eines Doktors der Wirtschaftswissenschaften
der Universit¨at Mannheim
vorgelegt von
Malte Hu¨bner
Juni 2009Abteilungssprecher: Prof. Tom Krebs, PhD
Referent: Prof. Dr. Eckhard Janeba
Korreferent: Prof. Dr. Robert Schwager
Tag der Verteidigung: Freitag, 20. November 2009Acknowledgements
First of all, I would like to thank my supervisor Eckhard Janeba for giving me the op-
portunity towork onthetopicspresented inthisthesis. Ialso appreciated hisinvaluable
guidance, instructive feedback and the great research environment at his chair.
This thesis has also benefitted a lot from helpful discussions with participants in the
priority program ”Institutional Design of Federal Systems” of the German Research
Foundation (DFG).
I am grateful to Robert Schwager for many helpful comments and discussions during
various workshops and for acting as a referee on my thesis committee.
During the time at the Chair of Public Finance I enjoyed working with my colleagues
Jennifer Abel-Koch, Nicole Borheier and Bj¨orn Sass and appreciated very much the
friendly atmosphere and the numerous constructive comments.
In the past five years I have also received a lot of support from my colleagues at the
Center for Doctoral Studies in Economics (CDSE) at the University of Mannheim. In
particular, I would like to thank the members of the class of 2004 Daniel Harenberg,
Michal Kowalik, Christoph Nagel, Heiner Schumacher and Gonzague Vannorenberghe
for the helpful advices, stimulating discussions and the team spirit during the time at
the CDSE.
Christoph Rothe has shown greatpatience in answering numerous questions aboutbasic
issues in applied econometrics.
Financial support from from the German Research Foundation (DFG) is gratefully ac-
knowleged.
Finally, I want to thank my parents for their support over the whole course of my
education.Contents
1 Educational Federalism 7
1.1 The model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
1.1.1 Occupational and Locational Choice . . . . . . . . . . . . . . . . 13
1.1.2 Comparative Statics . . . . . . . . . . . . . . . . . . . . . . . . . 14
1.2 Efficient Solution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
1.3 Centralization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
1.3.1 Pure Public Funding . . . . . . . . . . . . . . . . . . . . . . . . . 16
1.3.2 Tuition Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
1.4 Decentralization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
1.4.1 Pure Public Funding . . . . . . . . . . . . . . . . . . . . . . . . . 24
1.4.2 Tuition Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
1.4.3 Tuition Fees: Centralization vs. Decentralization . . . . . . . . . 29
1.4.4 Decentralization: Fees vs. Pure Public Funding . . . . . . . . . . 31
1.5 Summary and Concluding Remarks . . . . . . . . . . . . . . . . . . . . . 33
1.6 Mathematical Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . 34
1.7 Figures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
2 Preferential Fee Regimes 47
2.1 The Model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51
2.1.1 Occupational and Locational Choice . . . . . . . . . . . . . . . . 53
2.1.2 Welfare . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55
2.2 The First-Best Solution. . . . . . . . . . . . . . . . . . . . . . . . . . . . 56
2.3 Non-cooperative equilibrium . . . . . . . . . . . . . . . . . . . . . . . . . 57ii CONTENTS
2.3.1 No discrimination . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
2.3.2 Discrimination . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60
2.3.3 Welfare under discrimination. . . . . . . . . . . . . . . . . . . . . 63
2.3.4 Number of students under Discrimination . . . . . . . . . . . . . 64
2.3.5 Relation to the literature on preferential tax regimes . . . . . . . 66
2.4 Extensions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67
2.5 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69
2.6 Mathematical Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
2.7 A political economy version of the model . . . . . . . . . . . . . . . . . . 76
3 Do tuition fees affect enrollment behavior ? 89
3.1 The Literature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
3.2 Institutional Background . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
3.3 Data and Empirical Strategy . . . . . . . . . . . . . . . . . . . . . . . . . 96
3.3.1 Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
3.3.2 Estimation Strategy . . . . . . . . . . . . . . . . . . . . . . . . . 97
3.3.3 A model of university enrollment . . . . . . . . . . . . . . . . . . 100
3.4 Estimation Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
3.5 Summary and discussion of results . . . . . . . . . . . . . . . . . . . . . 110
3.6 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 112
4 Welfare Competition in Germany 119
4.1 Two theories of welfare competition . . . . . . . . . . . . . . . . . . . . . 122
4.2 Institutional Background . . . . . . . . . . . . . . . . . . . . . . . . . . . 125
4.2.1 Germany’s welfare system until 2004 . . . . . . . . . . . . . . . . 125
4.2.2 The Agenda 2010 Reform . . . . . . . . . . . . . . . . . . . . . . 127
4.3 Data and Empirical Strategy . . . . . . . . . . . . . . . . . . . . . . . . . 130
4.3.1 Econometric Issues . . . . . . . . . . . . . . . . . . . . . . . . . . 135
4.4 Estimation Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 138
4.4.1 Estimation Results for 2000 . . . . . . . . . . . . . . . . . . . . . 138
4.4.2 Estimation Results for 2006 and 2007 . . . . . . . . . . . . . . . . 141CONTENTS iii
4.5 Robustness and discussion of results . . . . . . . . . . . . . . . . . . . . . 149
4.5.1 The role of energy prices . . . . . . . . . . . . . . . . . . . . . . . 149
4.5.2 Identification of the centralization effect . . . . . . . . . . . . . . 150
4.5.3 Missing Data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 152
4.6 Summary and concluding remarks . . . . . . . . . . . . . . . . . . . . . . 152
4.7 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153
4.7.1 A small model of welfare competition . . . . . . . . . . . . . . . . 153
4.7.2 Tables and Figures . . . . . . . . . . . . . . . . . . . . . . . . . . 156Preface
This thesis consists of four essays that each relate to the horizontal interaction of gov-
ernments. All essays address an issue that is currently the topic of a public debate in
Germany. The first three chapters are concerned with the funding of higher education
in federal states. In particular they center around the question of how the introduction
of tuition fees might affect the quality of universities and the number of students in a
federation. The fourth essay investigates whether the German counties are engaged in
welfare competition.
In 2005 the German constitutional court lifted a ban that prevented the German states
- which are responsible fortheprovision ofhigher education - fromfinancing universities
with the help of tuition fees. Immediately afterwards some states announced that they
would make use of the possibility to introduce tuition fees, sparking a debate about the
likely consequences of this decision. While advocates of tuition fees pointed out that
additionalrevenuecouldbeusedtoimprovethequalityofuniversities,opponentswarned
that raising the costs of higher education would lower enrollment rates. At the same
time, a joined commission of the German parliament (Bundestag) and the Council of
constituent states (Bundesrat)was putinplace toreorganizethe fiscalrelations between
the central and state governments. As part of the reform the commission strengthened
the autonomy of the state governments over higher education policies. While the states
welcomed this gain in autonomy some observers warned that the mobility of students
wouldallowstategovernmentstofree-rideoneachother’sexpenditure,thusundermining
the incentives to invest into the quality of higher education.
These points of dispute show that there are two important dimensions along which the
organization of university funding can differ: The composition of public- and private
funds and the extent to which public funds are provided by the federal or sub-national
governments.
The purpose ofthefirstChapter ofthisthesis isto assess theoretically howthe composi-
tion of university funding and the degree of decentralization interact in determining the
equilibrium higher education policy. The question of how tuition fees affect participa-
tion in higher education is currently not only in Germany the subject of a controversial
debate. Despite this fact earlier work focussing on the funding of higher education in2 CONTENTS
federal states has assumed that the number of students is independent of higher edu-
cation policies (Gradstein and Justman 1995, Justman and Thisse 1997, Justman and
Thisse 2000, Bu¨ttner and Schwager 2004, Kemnitz 2005, Schwager 2008). Particular
emphasis is therefore given to the question of how variations in the institutional set-up
of a federation affect the participation in higher education.
This question is addressed with the help of a simple model in which universities are
operatedandfinancedeitherbyfederal-orstategovernments. Governments makecostly
investments into the quality of universities. Depending on the institutional set-up, they
are either restricted to finance universities out of public funds (pure public funding) or
might be allowed to augment public funds by the introduction of a tuition fee.
Individuals are mobile before and after attending university. Accordingly, not all stu-
dents pay taxes in the region where they graduated from university. Tax-payments
thereforeconstituteachannelthroughwhicheducationalexpenditurespillsovertoother
regions and distorts the spending decisions of state governments.
The model allows me to draw a number of interesting conclusions. The first result con-
cerns the introduction oftuition fees into a system ofpurely publicly funded universities
and points to an effect that has often been overlooked in the public debate: If govern-
ments lack sufficient instruments to tax the high-skilled population the introduction of
a tuition fee can raise the quality of universities as well as the number of students. This
result even holds when governments seek to maximize revenue and their interests are
thus not perfectly aligned with those of the students. The intuition for this result is
quite simple: In the absence oftuition fees constraints on raising the income tax rate re-
duces a governments’ incentive to invest into higher education as it does not participate
sufficiently inthe gains fromdoing so. Insuch a situation the availability ofa tuitionfee
can help to circumvent this constraint by restoring the incentives to improve the quality
of universities. Starting at low levels of quality the increase in income resulting from a
better university education exceeds the tuition fee and thus leads to a higher net income
and more students.
The model also shows that whether students fare better when the authority over the
higher education policy is assigned to the federal or state governments depends on the
relative strength of two effects: under decentralization the mobility of students creates
an incentive for state governments to attract future tax-payers by choosing a policy
that is favorable to students. On the other hand, not all graduates work in the region
where they attended university which means that a part of any investment into higher-
educationspillsovertootherregionsintheformofthetax-paymentsofmobilegraduates.
This effect therefore lowers the incentives to invest in high-quality tertiary education.
Whether decentralization benefits students therefore depends on the relative strength of
these effects.

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