6.h.

A subsidy versus a Voucher

Public schools are financed with government subsidies. Primary schools normally receive
a 100% subsidy, which reduces the price paid by students to zero. Public universities
receive a partial subsidy, which normally leaves the student paying a reduced price, but
still a positive price.

If education were not subsidized, students (or their parents) would purchase education on
the private market, using their own money. But with publicly funded education, the
government pays for the students education, using tax dollars that were paid by the
student. The average student pays for his education either way, either with direct fees
paid to a private school, or with tax dollars paid to a public school. But with public
education, the students choices are limited to the schools provided by the government.
Simple economic logic tells us that nobody will spend someone elses money as carefully
as they spend their own, so we would naturally expect that a system of government-run
schools will be inferior to what privately-operated schools would provide. We might
observe, for example, that public schools will be run more for the benefit of teachers than
for students.

Public financing of education is normally justified on the grounds of helping those

students who are too poor to pay for an education. If there were no public schools, then
poor people might save a little on their taxes, but would probably have to spend much
more on private schools.

Educational vouchers are sometimes proposed as a compromise measure between the

inefficient, one-size-fits-all public school system, and a system of private schools that
would be of higher quality, but unaffordable to the poor.

Suppose, however, the government said to you: If you relieve us of the expense
of schooling your child, you will be given a voucher, a piece of paper redeemable
for a designated sum of money, if, and only if, it is used to pay the cost of
schooling your child at an approved school. The sum of money might be $2000,
or it might be a lesser sum, say $1500 or $1000, in order to divide the savings
between you and the other taxpayers. But whether the full amount or the lesser
amount, it would remove at least a part of the financial penalty that now limits the
freedom of parents to choose. (Friedman, Free to Choose, 1979, p. 150.)
 y Figure 6.h.1 y Figure 6.h.2

270

voucher=$100 $100 voucher

170 No Subsidy 170

yB C
B
$100 Subsidy

Subsidy=$100 No voucher
A A

yD D

xB x (Education) x (Education)

The political issues surrounding educational financing are tangled and controversial, but
some of the economic issues are straightforward enough that they can be described in a
standard consumer choice diagram. In figure 6.h.1, a student who gets no subsidy to his
education reaches a consumers optimum at a point like A. Paying a subsidy to education
would make education cheaper, so the budget line would rotate outward as shown,
leaving the student at a new optimum at point B. The diagram gives a handy way to find
the amount of money the government spends on the subsidy. Note that at point B, the
student is consuming XB units of education, and YB units of other goods Y. If the student
had tried to consume XB units of education without the subsidy, he would have only been
able to afford YD units of other goods Y. Thus, the distance from B to D (i.e., YB -YD)
represents the number of units of y the government spends on the subsidy. If we assume
that Y is a numeraire good, meaning Py =$1, and if we arbitrarily say the government is
spending 100 units of y on the subsidy, then we can say that the government spends $100
subsidizing this students education.

Figure 6.h.2 shows what would happen if the government spent the same $100 on a
voucher, rather than a subsidy. A voucher that is redeemable for $100 worth of education
is much like a cash gift of $100. For example, suppose that the students could have
afforded, at most, 170 units of y without any government help. A $100 cash gift would
have increased the vertical intercept of his budget line from 170 to 270, as shown. The
difference between a voucher and a cash gift is that the voucher cannot be spent on
anything but education. So if the student could afford, at the most, 170 units of Y without
the voucher, he is still limited to 170 units of Y with the voucher. This means that the
voucher budget line can go no higher than the horizontal line at 170. In this case, the
voucher moves the students optimum from point A to point C, the same as a cash gift.
 y Figure 6.h.3

270

$100 voucher

170
C

yB
B
$100 Subsidy
Subsidy=
voucher=$100
A

yD D

xB x (Education)

Figure 6.h.3 allows us to compare a subsidy with a voucher. As before, a $100 subsidy to
education flattens the budget line, causing it to rotate outward as shown, and allowing the
student to reach a new optimum at point B. But if the same $100 had instead been spent
on a voucher, the budget line would have shifted up by $100 without changing its slope.
This means that the voucher budget line shown must pass through point B, since we
already know that B is $100 above the point D, on the original budget line. Note that the
voucher budget line cuts through the indifference curve at point B, and allows the student
to reach a higher indifference curve at point C. In other words, the student will always
prefer a $100 voucher to a $100 subsidy! But since the voucher leaves the student
consuming less education than the subsidy (C is to the left of B.), we would expect
teachers to oppose vouchers, since the voucher would lead to less demand for teachers.
 y Figure 6.h.4

270

$100 voucher

A C
170

yB
B
$100 Subsidy
Subsidy=
voucher=$100

yD D

xB x (Education)

A voucher does not always leave the student consuming less education. Figure 6.h.4
shows the case of a student who, with no government assistance, chooses to consume no
education. On the original, unsubsidized budget line (passing through points A and D),
this consumers highest indifference curve is reached at point A, with the student
consuming no education. This kind of optimum is known as a corner solution. A subsidy
to education will cause the budget line to flatten as shown, but in this case the subsidy
leaves the student at point A, still consuming no education in spite of the subsidy. The
voucher, however, makes a higher indifference curve attainable at point C. In this case, it
is the voucher that is more effective, in the sense that it causes the student to consume
more education than the subsidy.