Life Cycle Earnings, Education Premiums and Internal Rates of Return

Abstract

What do the education premiums look like over the life cycle? What is the impact of schooling on lifetime earnings? How does the internal rate of return compare with opportunity cost of funds? To what extent do progressive taxes attenuate the incentives to invest in education? This paper exploits Norwegian population panel data with nearly career long earnings histories to answer these important questions. We provide a detailed picture of the causal relationship between schooling and earnings over the life cycle, following individuals over their working lifespan. To account for endogeneity of schooling, we apply three commonly used identification strategies. Our estimates show that additional schooling gives higher lifetime earnings and steeper age-earnings profile, in line with predictions from human capital theory. These estimates imply an internal rate of return of around 10 percent, after taking into account income taxes and earnings-related pension entitlements. Under standard conditions, this finding suggests it was financially profitable to take additional schooling because the rates of return were substantially higher than the market interest rates. By comparison, Mincer regressions understate substantially the rates of return. We explore the reasons for this downward bias, finding that it is driven by Mincer's assumptions of no earnings while in school and exogenous post-schooling employment. JEL classification: J24, J31

More Education, Less Volatility? The Effect of Education on Earnings Volatility over the Life Cycle

“…Using a very different estimation method, Buscha and Dickson (2015) show a broadly similar pattern of increasing then decreasing returns using the NESPD. Our estimates are, however, in contrast to results from Norway which show that the returns are typically lower at the beginning of the life cycle and higher at the end (Bhuller et al 2017). …”

“…Recent research (Bhuller et al (2017), Buscha and Dickson (2015)) has emphasised the importance of variation in the return to education over the life cycle. In Table 2 we also show results where we pool across ages.…”

Nudging in education

“…For example, Heckman, Lochner, and Todd (2006) report large internal rates of return for schooling under rather flexible assumptions and find that the returns are particularly large for secondary school completion in the US. A more recent study, Bhuller, Mogstad, and Salvanes (2017), finds that even in a country like Norway, with its progressive tax and pension systems, the internal rate of return from schooling is around 10%. Education also has non-productive benefits on crime, health and good citizenship (Lochner, 2011).…”

The Supply of Skill and Endogenous Technical Change: Evidence from a College Expansion Reform

“…11 Although the mandatory retirement age is 67 years, about 80% of Norwegian workers are entitled to receive early retirement benefits beginning at age 62 years (Bhuller, Mogstad, and Salvanes, 2015). Annual earnings of 1G are the lowest threshold for earning pension points in the national pension scheme.…”