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Economic Impact of Higher Education – Understanding the Value of Higher Education November 13-15, 2005 copies of this presentation can be found at www.business.duq.edu/faculty/davies. Growth in Tuition Over Time.

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slide1

Economic Impact of Higher Education – Understanding the Value of Higher Education

November 13-15, 2005

copies of this presentation can be found at

www.business.duq.edu/faculty/davies

slide2

Growth in Tuition Over Time

College tuition has increased 7% annually while consumer inflation has averaged only 4.5% annually.

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide3

Cost of Education Relative to Household Income

College tuition has grown from 20% of household income in 1976 to over 45% in 2003.

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide4

Sources of Benefits to Higher Education

  • Benefits of a college education vs. a high school education
  • Difference in entry-level wages.
  • Difference in the growth rates of wages over the course of a career.
  • Difference in the likelihoods of employment.
slide5

Difference in Entry-Level Wages

Starting salaries 42% higher for degreed workers

Source: Statistical Abstract of the United States, 2004-2005

slide6

Difference in Growth Rate of Wages

Salaries grow 1.1%-points faster for degreed workers

Source: Statistical Abstract of the United States, 2004-2005

slide7

Difference in Likelihoods of Employment

Likelihood of employment 15%-points greater for degreed workers

Source: Statistical Abstract of the United States, 2004-2005

slide8

Expected Earnings

(Earnings) (Probability of Employment) = Expected Earnings

slide9

Expected Earnings

Annual Earnings (18-65 year olds)

The average working college graduate earns 113% more than the average working high school graduate.

Expected Annual Earnings (18-65 year olds)

The average college graduate earns 167% more than the average high school graduate.

slide10

Compensation-Expense Comparison

$184,000 difference by age 21

High school graduate enters workforce at age 18 and begins to accumulate earnings.

College student starts college education at age 18 and begins to accumulate debt.

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide11

Compensation-Expense Comparison

In 1977, difference was $45,000

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide12

Compensation-Expense Comparison

Breakeven at age 28

Cumulative expected difference was $375,000 in 1977

After finishing college, the college student’s earnings begin to outpace the high school graduate’s earnings.

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide13

Compensation-Expense Comparison

Breakeven at age 25

Cumulative expected difference is $2.3 million in 2005

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide14

Evaluating the Benefit of Higher Education

  • Three ways to evaluate the benefit of an investment
  • Breakeven Point
  • Internal Rate of Return
  • Net Present Value
slide15

Evaluating the Benefit of a College Education

Breakeven Point

How many years will it take to recoup investment?

Example

Invest $10,000 and receive $1,000 each year for 20 years.

Breakeven = 10 years

1977

Cost of college plus lost compensation $63,000 (in 1977$)

Benefit of college $375,000 (in 1977$)

Breakeven: 11.4 years

2002

Cost of college plus lost compensation $184,000 (in 2002$)

Benefit of college $2.3 million (in 2002$)

Breakeven: 9.1 years

slide16

Evaluating the Benefit of a College Education

The breakeven period on a college education has fallen from 11 years in 1977 to 9 years today.

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide17

Evaluating the Benefit of a College Education

Internal Rate of Return

The benefit represents what rate of return on the investment?

Example

Invest $10,000 and receive $10,800 back one year in the future.

IRR = 8%

1977

Cost of college plus lost compensation $63,000 (in 1977$)

Benefit of college $375,000 (in 1977$)

Real IRR (rate of return after inflation): 13.9%

2002

Cost of college plus lost compensation $184,000 (in 2002$)

Benefit of college $2.3 million (in 2002$)

Real IRR (rate of return after inflation): 17.2%

slide18

Evaluating the Benefit of a College Education

The real rate of return on a college education has risen from less than 14% in 1977 to over 17% today.

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide19

Evaluating the Benefit of a College Education

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide20

Evaluating the Benefit of a College Education

Net Present Value

The net future benefit is equivalent to what lump-sum amount today?

Example

Giving up $10,000 today and receiving $1,000 each year for 20 years is the same as receiving $2,462 today (assuming 5% market interest).

1977

Cost of college plus lost compensation $63,000 (in 1977$)

Benefit of college $370,000 (in 1977$)

Net Present Value: $163,000 (in 1977$)

$524,000 (in 2005$)

2005

Cost of college plus lost compensation $220,000 (in 2005$)

Benefit of college $2.4 million (in 2005$)

Net Present Value: $1,035,000 (in 2005$)

slide21

Evaluating the Benefit of a College Education

The present value of a college education net of tuition has doubled over the past 25 years.

Source: Statistical Abstract of the United States, 1995-2002, Current Population Reports, Bureau of the Census, 1997, Annual Survey of Colleges, The College Board, 2002

slide22

These Estimates are Conservative

Assumed: Tuition is $19,700 per year (average for 4-year private institutions in 2002).

Reality: More than 70% of students pay less than $10,000 per year, and 50% of students pay less than $6,000 per year.

Assumed: No financial aid.

Reality: Grant aid averaged $3,600 per student in 2002.

Assumed: No tuition discounting.

Reality: Average 4-Year private institution discounted 39% in 2002.

slide23

Implications of Tuition as an Expense vs. Investment

Reducing loan interest rates causes a reduction in liquidity.

Reduction in liquidity prevents students from leveraging future income gains  students forced to find current income sources to fund educations.

Misperception of tuition as an expense, rather than investment, is reinforced.

Comparing tuition to household income  reduce the cost of loans regardless of the future income generated by the loans.

slide24

Perceived Burden of Tuition Debt

20% of graduates report at least a “high” debt burden when their loan payments rise above 12% of their gross incomes.

50% of graduates report at least a “moderate” debt burden when their loan payments rise above 8% of their gross incomes.

High Pain

Moderate

Low Pain

Source: College on Credit: How Borrowers Perceive their Education Debt, Nellie Mae Corporation, 2003.

slide25

100% of Tuition & Related Fees Financed via Debt

High Pain

Moderate

Low Pain

If loan terms were extended to 20 years, banks could charge almost 6% interest on student loans before students started to feel “moderate” pain from student loan debt.

slide26

100% of Tuition & Related Fees Financed via Debt

High Pain

Moderate

Low Pain

If loan terms remained at 10 years, but loan payments were made in pre-tax dollars, banks could charge over 8% interest on student loans before students started to feel “high” pain from student loan debt.

slide27

100% of Tuition & Related Fees Financed via Debt

If loan terms were extended to 20 years and loan payments were made in pre-tax dollars, banks could charge more than 9% interest on student loans before students started to feel “moderate” pain from student loan debt.

High Pain

Moderate

Low Pain

slide28

Thoughts Outside the Box

Conclusion:

Reducing loan interest rates solves a problem that doesn’t exist, and may introduce a problem that wouldn’t have existed otherwise.

slide29

Thoughts Outside the Box

  • Government can encourage markets to provide more liquidity
  • Allow market rates to prevail  e.g. 12% interest rate on

college loans

  • Employers deduct student loan payments from paychecks
    • No additional cost: use existing withholding infrastructure
    • Reduces loan default costs
  • Loan payments capped at 15% (?) of gross income
    • Life of loan can vary so that loan is paid in full given cap
    • Automatically provides relief during unemployment
slide30

Thoughts Outside the Box

  • Government can encourage markets to provide more liquidity
  • Tuition loan payments in pre-tax dollars
    • Current tax treatment reinforces “tuition as expense”
  • Possibly revenue neutral; maybe revenue positive
    • No government cost of loan guarantees
    • No government cost of interest rate subsidies
    • No government cost of grants
    • College graduates generate $700,000 more in wage taxes

net of increased Social Security retirement benefits than

high school graduates

slide31

Expected Wage Tax Revenue

A college graduate generates $740,000 more in wage tax receipts (2003$) than a high school graduate.

slide32

Expected Wage Tax Revenue

A college graduate generates $700,000 more in net wage tax receipts (2003$) than a high school graduate, after accounting for increased Social Security benefits.

slide33

Interesting Market Evolution

Students charged different rates on the basis of secondary school performance, university performance, selected major, and demonstrated ability.

  • Students pursuing degrees that lead to better paying jobs will be charged lower interest rates
    • Incentive to students to pursue more valuable careers impacts at time of enrollment rather than post-graduation (when it is too late to affect behavior)
  • Interest rates become a market metric of the quality of secondary-school preparation and university education
    • Incentive to universities to make educations relevant impacts at time of enrollment rather than generations later
slide34

Education as an Export

Higher education is a significant U.S. export

US exports of higher education increased from $3.5 billion in 1986 to $12.8 billion in 2002.

 Annual growth rate of 8.4%.

slide35

Education as an Export

Foreign students studying in the U.S. contributed $13 billion to the U.S. economy in 2002. Education is the fourth largest source of net exports in the U.S.

Source: International Trade Association, 2003, National Center for Policy Analysis, 2001, Bureau of Economic Analysis, 2003.

slide36

Education as an Export

Education is one of only six categories that has exhibited net export growth over the past fifteen years.

Source: International Trade Association, 2003, National Center for Policy Analysis, 2001, Bureau of Economic Analysis, 2003.

slide37

Some Pending Legislation

  • Pending legislation falls (roughly) into three groups:
  • Legislation to control tuition or tuition growth.
  • 2. Legislation to provide tuition tax incentives.
  • 3. Legislation to provide tuition loan forgiveness.
slide38

Unintended Consequences of Price/Growth Controls

 Colleges quote a “sticker price” and then discount from that price on the basis of student need and academic strength.

 Colleges use tuition discounting to transfer tuition costs from less needy to more needy students.

Unintended consequence: Price/growth controls will prevent the transfer of tuition costs from less needy to more needy students.

Unintended consequence: Price/growth controls will result in fewer needy students attending college.

slide39

Unintended Consequences of Price/Growth Controls

 Dollars foreign students spend in the U.S. on education and living are part of U.S. exports.

Unintended consequence: Price/growth controls will slow U.S. education exports resulting in a worsening of the trade deficit.

Unintended consequence: Price/growth controls will prevent the transfer of tuition costs from American to foreign students (via tuition discounting), benefiting foreign students at the expense of American students.

slide40

Unintended Consequences of Tax Incentives

  •  Needy students’ families pay relatively little income tax.
  • Wealthy students’ families pay no Social Security tax (at the margin).

Unintended Consequence: Making tuition payments free of Federal/State taxes, but not Social Security tax, benefits families of wealthy students and has little effect on families of needy students.

slide41

Unintended Consequences of Loan Forgiveness

 Proposed legislation allows loan forgiveness for students entering select career fields: public service, teaching, early childhood education, nursing, child welfare, nutrition.

Unintended Consequence: Encourages more students to enter these select fields. Wages in those fields will decline.

Unintended Consequence: As wages decline in the select fields, the most talented workers will leave for less crowded fields resulting in a decline in the average quality of workers in the select fields.

slide42

Economic Impact of Higher Education – Understanding the Value of Higher Education

November 13-15, 2005

copies of this presentation can be found at

www.business.duq.edu/faculty/davies