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Making the Grade: The Economics of Education Chief of Staff Retreat February 22-24, 2007 copies of this presentation can be found at www.business.duq.edu/faculty/davies. The cost of private college has increased 7.9% annually while consumer inflation has averaged only 4.4% annually.

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slide1

Making the Grade: The Economics of Education

Chief of Staff Retreat

February 22-24, 2007

copies of this presentation can be found at

www.business.duq.edu/faculty/davies

slide2

The cost of private college has increased 7.9% annually while consumer inflation has averaged only 4.4% annually.

Source: Statistical Abstract of the United States, 1995-2006; Current Population Reports, Bureau of Census, 1978-1997; Annual Survey of Colleges, The College Board, 2002

slide3

The cost of one year’s college education has grown from 20% of household income in 1976 to almost 50% today.

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

slide4

Benefits of a college education vs. a high school education

  • Difference in entry-level compensations.
  • Difference in the growth rates of wages over the course of a career.
  • Difference in the likelihoods of employment.
slide5

Starting compensation is 85% higher for degreed workers.

Source: Statistical Abstract of the United States

slide6

Real salaries grow faster for degreed workers by almost 1% annually.

Over a 40-year career, that cumulates to a 30% to 50% difference in wages.

Source: Statistical Abstract of the United States

slide7

The likelihood of employment is 15 percentage points greater for degreed workers.

Source: Statistical Abstract of the United States

slide8

Expected Compensation = (Compensation) (Probability of Employment)

  • The median working college graduate earns 112% more than the median working high school graduate.
  • Accounting for the likelihood of employment, the median college graduate can expect to earn 144% more than the median high school graduate.
slide9

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

$180,000 difference by age 21

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

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

slide10

In 1977, difference was $47,000

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

slide11

In 1977, the cumulative expected difference was $1.1 million (in 2006$)

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

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

slide12

By 2006, the lifetime expected payoff from a college education had grown 180% to $2 million.

 Net of inflation and net of tuition increases

$2 million

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

slide13

The bulk of the difference is due to the fact that a HS diploma has lost much of its value.

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

slide14

Lifetime earnings less tuition of college graduates rose $250,000.

Lifetime earnings of high school graduates declined $650,000.

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

slide15

Three ways to evaluate the benefit of an investment

  • Breakeven Point
  • Internal Rate of Return
  • Net Present Value
slide16

1977 (private college costs)

Cost of college plus lost compensation $60,000 (in 1977$)

Benefit of college degree vs. HS diploma $360,000 (in 1977$)

Breakeven: 10 years

Breakeven Point

How many years (from matriculation) will it take to recoup investment?

Example

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

Breakeven = 10 years

2006 (private college costs)

Cost of college plus lost compensation $220,000 (in 2006$)

Benefit of college degree vs. HS diploma $2 million (in 2006$)

Breakeven: 10 years

slide17

The breakeven period on a college education has remained approximately 10 years despite increases in tuition.

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

slide18

1977 (private college costs)

Cost of college plus lost compensation $60,000 (in 1977$)

Benefit of college degree vs. HS diploma $360,000 (in 1977$)

Real rate of return (return less inflation): 15%

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%

2006 (private college costs)

Cost of college plus lost compensation $220,000 (in 2006$)

Benefit of college degree vs. HS diploma $2 million (in 2006$)

Real rate of return (return less inflation): 16%

slide19

The real rate of return (return less inflation) on a college education has remained approximately 16% despite increases in tuition.

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

slide20

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

slide21

1977 (private college costs)

Cost of college plus lost compensation $60,000 (in 1977$)

Benefit of college degree vs. HS diploma $360,000 (in 1977$)

Net Present Value: $500,000 (in 2006$)

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).

2006 (private college costs)

Cost of college plus lost compensation $220,000 (in 2006$)

Benefit of college degree vs. HS diploma $2 million (in 2006$)

Net Present Value: $850,000 (in 2006$)

slide22

The present value of a college education net of tuition and inflation has increased by 70% over the past 25 years.

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

slide23

Why has the value of a college degree been rising?

  • Absolute value argument
  • Value of the skills taught in higher education has been rising.
  • Relative value argument
  • Value of the skills taught in secondary education has been falling.
  • Signaling argument
  • Higher education is becoming a signal for ability.
  • Coincidence argument
  • As incomes rise, people who would earn more anyway are also drawn to attend college.
slide24

Absolute value argument

Value of the skills taught in higher education has been rising.

Evidence suggests that the value of skills taught in higher education has risen by $250,000 (in 2006$) over the past 30 years.

slide25

Relative value argument

Value of the skills taught in secondary education has been falling.

Evidence suggests that the value of skills taught in secondary education has fallen by $650,000 (in 2006$) over the past 30 years.

slide26

Signaling argument

Higher education is becoming a signal for ability.

For the signaling argument to hold, the signaling quality of a degree must outweigh the combination of four years’ of foregone job experience plus the $180,000 cost of the college degree.

Also, the argument does not explain the $650,000 decline in the value of the high school diploma.

slide27

Coincidence argument

As incomes rise, people who would earn more anyway now also are drawn to attend college.

One way to test this is to take people of the same inherent ability, put some in college, and some directly into the work force. If the coincidence argument is correct, then we should see no difference in earnings between the two groups.

Let the two groups be blacks and whites. Assume the same inherent ability.

slide28

If the coincidence argument holds, we should observe no change in relative earnings between the two groups as relative college completion between the two groups changes.

slide29

In fact, we see a marked increase in relative earnings as the relative completion rate rises. This contradicts the coincidence argument.

Source: Current Population Survey, U.S. Census Bureau, Tables A-2 and A-3.

slide30

Do taxes impact the value of education?

A progressive tax structure diminishes the financial value of education by reducing the financial gain to holding a degree.

slide31

7.9% difference

9.7% difference

Total Effective Federal Tax Rates

The tax structure causes college graduates to bear a greater tax burden.

Source: Statistical Abstract of the United States; Current Population Reports, Bureau of Census;Congressional Budget Office.

slide32

Expected Additional Lifetime Tax Burden from Obtaining a College Degree (NPV, 2005$)

The additional tax burden on college graduates has been rising at 5.5% annually over the past 25 years.

Source: Statistical Abstract of the United States; Current Population Reports, Bureau of Census;Congressional Budget Office.

slide33

Total Cost of Obtaining a College Degree (tuition plus additional tax burden) (NPV, 2005$)

The additional tax burden of holding a college degree is currently three times the cost of four years’ tuition.

Source: Statistical Abstract of the United States; Current Population Reports, Bureau of Census;Congressional Budget Office.

slide34

Total = $3.4 m.

Total = $3.3 m.

– $250 k

Added Tax Burden

– $150 k

Added Tax Burden

Added Value of Higher Education

+ $1.1 m.

Added Value of Higher Education

+ $2.0 m.

Value of Secondary Education

+ $2.3 m.

Value of Secondary Education

+ $1.7 m.

slide35

Liquidity pain points

  • Amount of loan
  • Duration of loan
  • Interest rate
  • Co-signer requirement

Summarized in the monthly payment

  • Question
  • If higher education is such a good value, why the controversy over the cost of education?
  • Problem is not cost vs. benefit, but cost vs. liquidity.
slide36

High Pain

Self-Reported Pain from Student Loan Payments (college graduates)

Moderate Pain

Low Pain

At typical student loan rates, students who are paying back loans report low levels of pain.

Loan Interest Rate

Source: Trends in Student Aid, The College Board, 2005;College on Credit: How Borrowers Perceive their Education Debt, Nellie Mae Corporation, 2003

slide37

Liquidity pain points

  • Amount of loan
  • Duration of loan
  • Interest rate
  • Co-signer requirement

Summarized in the monthly payment

The survey suggests that co-signer requirements may be the source of perceived illiquidity.

slide38

Since 1995, PLUS loans have grown 360% while Alternative loans have grown over 1,000%.

  • PLUS Loans
  • Deferrable
  • Lower subsidized interest rate
  • No co-signer release option
  • Alternative Loans
  • Not deferrable
  • Higher market interest rate
  • Co-signer release option

Conclusion

Perceived illiquidity may be due to parents being unwilling to co-sign debt long term.

slide39

Conclusions

Tuition is not a problem.

Even after accounting for tuition growth, a college degree adds 70% more value today than it did in 1977.

Liquidity is a problem.

Parents are unwilling/unable to co-sign long term loans.

Tax structure reduces incentive to obtain higher education.

The additional tax burden imposed on graduates is three times the cost of four years’ tuition.

Value of secondary education is a problem.

The decline in the value of secondary education has offset more than 60% of the increase in the value of higher education.

slide40

Making the Grade: The Economics of Education

Chief of Staff Retreat

February 24-25, 2006

copies of this presentation can be found at

www.business.duq.edu/faculty/davies