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Life cycle earnings, education premiums and internal rates of return

Bhuller, Manudeep; Mogstad, Magne; Salvanes, Kjell Gunnar
Working paper
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URI
http://hdl.handle.net/11250/196940
Date
2014-06
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  • Discussion papers (SAM) [607]
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.
Publisher
Norwegian School of Economics. Department of Economics
Series
Discussion paper;24/2014

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