Transitory Earnings Opportunities and Educational Scarring of Men

I study how transitory increases in the opportunity cost of schooling affect dropout rates and long-run outcomes. Exploiting a tax-free year in Iceland and comparing teenagers around compulsory schooling age, I document increased dropout rates and a permanent loss in educational attainment for men, but not women. Consequently, they experience substantial lifetime earnings losses, enter occupations with limited career advancement, and are less likely to marry or have children. I show that these findings can be rationalized by a model of schooling decisions in which students either underestimate the returns to education or overestimate how easily they can return to school later. Consistent with the former, dropouts come disproportionately from families where parents earn well despite low education—an environment likely to lead children to underestimate the returns to schooling. These findings show that temporary shocks to the opportunity cost of schooling can leave permanent scars on human capital, with implications for age-dependent taxation and the costs of macroeconomic booms.