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A new model for financing higher education Tim Curtin. Origins of this paper.

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Origins of this paper

  • J. S. Mill (1848): “the intervention of government [in education] is justifiable, because …the supply of [students] called forth by the demand of the market will be anything but what is really required”. In 1848 there was no state education, not even at the primary level, nor very much taxation. Had there been Mill would have seen that state intervention could BEST be accomplished by my model’s combining privatisation with state support via tax credits.

  • Milton “vouchers” Friedman also missed an opportunity – this model is preferable because it more closely approximates the competitive solution by allowing fee flexibility.

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A New Model

  • Grant all universities complete financial autonomy, with freedom to set and collect fees from students;

  • Abolish HECS and allow all paying fees up-front an equivalent tax credit against their tax liabilities;

  • Place onus on government to address its equity objectives by providing non-refundable grants to those unable to pay fees, defined by means testing, relying only on the general tax system to recoup the cost of subsidies from enhanced future earnings of recipients.

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1. Financial autonomy for universities

  • With at least 40 universities in the sector, there would be more competition than in many Australian industries (eg banks, insurance, cars, petrol, media) and therefore cartelised fee rigging would be unlikely;

  • But to guard against fee rigging, the higher education sector could be made subject to the ACCC (Australian Competition and Consumers Commission).

  • No other regulation would be necessary apart from quality assurance (AUQA) and accreditation.

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2. Tax creditable fees

  • Those paying fees up-front obtain an equivalent tax credit against their tax liabilities;

  • This means that the total cost of fees paid may be offset against income tax liabilities;

  • In other words, fees paid are deemed to be taxes paid in the same amount;

  • Those with annual income tax less than current fees would be able to carry forward their tax credit.

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3. Grants for those unable to pay fees upfront

  • Government to provide non-refundable scholarships to those unable to pay the fees, defined by appropriate means testing, say $30,000.

  • Rely only on the ordinary tax system to recoup the cost of these subsidies from the enhanced future earnings of the recipients;

  • That means HECS would be abolished (for all students) because it is unnecessary.

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Possible objections

  • Some of my critics have suggested many perhaps all universities would take advantage of the tax crediting of fees to push up fees in a rent seeking exercise, knowing that the government not parents would bear the cost through lower tax collections.

  • There is enough competition to make this unlikely across the board, and universities would have to be precise about their demand curves lest they achieve only net loss, because fees of say $20000 eliminate 90 per cent of parents if no carry forward of tax credits is allowed

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Room for flexibility

  • The risk of loading fees could be reduced by restricting the tax credit to say 90 per cent of the fee

  • But that destroys simplicity of the full credit

  • And at the margin (incomes of $30,000) would increase demand for grants.

  • More generally, it seems best to trust market forces: after all, petrol does not cost $2 a litre even though most is sold to businesses for whom it is a deductible expense.

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Tax Credits versus Deductions

  • The next slide demonstrates that ordinary tax deductibility for fees is regressive under a progressive rates income tax system, and that

  • In addition deductibility does not recover the full cost of the outlay on fees.

  • Tax crediting (or offsets) recovers the full cost for all taxpayers paying tax at least equal to the fee

  • For those whose tax is less than the fee either the credits should be carried forward or grants should be payable.

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“Win-win” outcomes 1. Government

  • Subjecting HE to market forces creates efficiency gains for the national economy;

  • No net extra costs to government from revenue loss from tax-creditable fees because of offset from ending annual operating grants to universities (c. $5 billion pa)

  • Not more than 5-10 per cent of all students will need the non-refundable state grants ($300-$600 million);

  • Administration savings at DEST offset this – any shortfall amply covered by general surplus of graduates’ taxation over costs of their HE.

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2. Parents and Students

  • All parents paying upfront tuition fees would reduce their income tax payments by the SAME amount;

  • HECS would be abolished for ALL students;

  • So e.g. law graduates earning above the repayment threshold of $24,365 save around $37,708 (including interest at 3.5% under current system).

  • Top marginal rate of income tax after abolition of HECS reverts to 47 per cent from the previous 53%

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Why a new model? What’s wrong with the present system?

  • Although HECS notionally a fee It does not free universities from often arbitrary fee rates, allocations, and other interference by government in what is taught and to whom (eg speculative manpower planning – guesses, e.g. how many nurses, IT and maths teachers are needed?) Do mortgage lenders dictate how one uses houses?

  • It has its origins in deeply flawed claims of the Wran Committee whose members invented HECS in 1988; any system based on their misleading economics and statistics is unlikely to be optimal.

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What’s wrong with HECS? cont.

  • Although HECS formally just a loan with repayments through tax system, in cash flow terms it is a tax. For a considerable period it amounts to double taxation of the extra income on which graduates already pay higher income taxes by virtue of their enhanced earnings;

  • HECS also taxes what governments claim to want to encourage, not discourage, like smoking via tobacco taxes; and it compounds discrimination of the tax system against human capital formation when added to the disallowance of spending on fees as tax deductible like other investments.

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Tax credits #1

  • The tax credit for fees paid is analogous with firms’ tax deductions on their capital spending;

  • However such deductions are allowable only for spending intended to generate income. Parents paying fees for their offspring will not themselves benefit from the income generated and taxable;

  • This implies students should be required to pay their own fees; many would need to borrow, but fees plus interest should then be tax credits against their own future income tax.

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Tax credits #2

  • That seems similar to HECS but is not because universities still obtain full value of fees charged upfront, unlike HECS (see flow charts).

  • But whilst it may offend tax purists, allowing parents to earn tax credits by paying fees for their offspring seems a valid special case –

  • Because if families are deemed to be inter-generational enterprises this treatment remains consistent with tax principles for depreciation of capital spending.

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Tax credits #3

  • Andrews (HLR 1972) explains taxation as the mechanism for transferring resources from private to public purposes;

  • If higher education is privatised then that means it ceases to be a public purpose and revenues previously raised thereto should be transferred back to the first instance financiers (via tax credits) as should have happened with HECS.

  • Note that charitable donations are already tax deductible, so in principle “donations” of fees on behalf of offspring should also be acceptable, but as credits.

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How many are eligible for fee credits?

  • ABS data on income distribution show that 85 per cent of Australian taxpayers have income above $30,000 a year, liable for gross income tax of at least $7,000 a year (ATO). For all these paying fees of c$7-10,000 per student would result in zero taxes for at least the three years of offspring study.

  • Tax credits in excess of annual tax liability could be carried forward, so at least 90% of parents of HE students would be eligible for tax credits

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Market research for universities

  • The 2001 Census (ABS 2002) indicates there were 7 million Australians aged 35-64 (ages of most parents of students) of whom 48% had incomes of over $31,148 a year. But a higher proportion of families had incomes in excess of $31,148 – in fact 60% of “income units” (households) had average incomes > $28,000 in 1999-2000 (ABS 2001).

  • But only 11.5 per cent of units in the lower two quintiles were couples with dependent children – and only 10.3 per cent of all couples with dependent children had incomes in the lower two quintiles.

  • Hence grants only needed for max. 10% parents.

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Is the new model free education?

  • Yes, in the sense that all paying fees will be eligible to claim equal tax credits on their ATO tax returns;

  • No, in the sense that a farmer’s tractor is not free even though he can claim a tax deduction – the fee is still paid in cash to the university, for which it is real income (unlike HECS repayments); the fee and credit are a real transfer of resources, but from parents to universities not government.

  • HECS repayments accrue only to consolidated revenue and have no impact at all on the level of government’s operating grants paid to universities.

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Will the Students Union understand this model?

  • Probably not. Any mention of fees could well provoke a riot, so to repeat:

  • Fees paid will result in equal reductions in tax (as they should when parents relieve government of the responsibility).

  • HECS will be abolished.

  • Grants will be available for the 10 per cent of all households with dependent children who are in the lower two income quintiles.

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Will government ministers and bureaucrats support this model?

  • Fortunately there is a precedent in America’s “HOPE” tax credit scheme introduced in 1997, and this is perhaps one area where Australia need not be afraid of following a trail blazed by Bill Clinton.

  • But HOPE is limited in amount to the level of fees charged by heavily subsidised public colleges.

  • An Australian precedent is tax offsets for private medical insurance (same as credits).

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The Wran Committee’s Misconceptions model?

  • Claiming that free tuition prior to HECS somehow perpetuated inadequate access of the under-privileged to higher education, and therefore introduction of fees paid through a graduate tax like HECS would have no impact on enrolments of the under-privileged.

  • Claiming that although graduates soon find themselves in the top 22 per cent of all income recipients, they “contribute very little directly to the costs of provision”.

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Wran’s first misconception model?

  • Participation of upper socio-economic groups prior to Wran was indeed out of line with their share of the population of university age - but NOT hugely out of line with their share of Y12 completers.

  • Although manual groups’ participation in HE was less than their shares of the population and of Y 12 completers in 1980, the disproportion fell by 1989, then widened to much worse by 1999 than in 1980.

  • For BOTH manual and non-manual, not just the former, HECS has led to falling participation between 1994 and 1999, back to LESS than it was in 1980 (see Fig 1).

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Proof of pudding model?

  • Martin and Karmel (DEST 2003) concluded that participation at “university in terms of proportion of a cohort going to university peaked in 1996”, and showed (Fig.3) that participation declined by nearly 10 per cent after 1996 for all students, although less markedly for students aged 20 and under (Fig.4).

  • Data in my own charts also confirmed by press reports on 21st August 2003 of a fall in applications for entrance to universities for the SECOND year in a row.

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Wran Misrepresentation #1 model?

  • “a no charge public university system (that is, financed by all taxpayers) is regressive” (Chapman & Ryan 2002, p.14) because graduates become well-off “at the expense of most taxpayers who are not graduates”. But: The overall tax system is progressive, and graduates’ taxation even more so, because they are mostly in upper reaches of the income distribution (see Charts)

  • The bottom 50 per cent of households pay no net taxes at all (they receive instead net cash benefits), and graduates are predominantly in the top 50% of all tax payers who alone pay net tax.

  • Above all the tax creditable fee means that taxpayers not using HE do not contribute to costs.

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Wran Misrepresentation #2 model?

  • Wran and authors like Barr (1998) Chapman (1997) Greenaway (2003) agree that HE creates social benefits but claim these are non-quantifiable, and pale beside enormous exclusively private benefits of graduates, but

  • They completely ignore the very quantifiable TAXES payable on those private benefits that constitute enormous social CASH benefits to government and society.

  • Graduates’ income taxes alone in Australia run at c$25 billion a year, FIVE times more than public spending on HE tuition (Table 3 in my paper).

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Another Wran fallacy model?

  • Wran’s proposals for HECS were explicitly based on the assumption that whilst upfront fees might deter applicants for HE, if fees were deferred as by HECS, there would be no such deterrent effect.

  • The implied economics is that demand for HE is elastic in the case of upfront charges and absolutely inelastic for charges in the future.

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False Accounting model?

  • The stubborn refusal of all education economists to acknowledge that graduates’ higher incomes incur higher taxation is equivalent to Enron-type false accounting which also hid taxes etc.

  • Investors have engaged in successful class actions against the banks (JP Morgan etc) who connived at Enron’s fake accounts;

  • All paying HECS in Australia could have equal grounds for class actions against the authors of HECS because it was based on misleading cost-benefit analysis.

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Equity model?

  • HECS appears to be equitable but discriminates between “A” graduates whose fees were paid for them and “B” graduates repaying HECS.

  • That means in critical early earning years, A graduates pay ordinary tax rates of 30-47 per cent, while B graduates pay at rates of 33-53 per cent.

  • This is contrary to Adam Smith’s “ability to pay” tax rule (equal tax for equal income, cet.par.)

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Equity cont. model?

  • Some have argued (eg Greenaway & Haynes 2001) that it is “unfair” if non-graduates and graduates with the same incomes pay the same income tax when the latter received subsidised HE.

  • Smith’s ability to pay rule overrides this, also:

  • These non-graduates clearly have superior ability to those graduates.

  • It is only because the others are graduates that they earn as much as these clever non-graduates – but then they pay more tax than if they had not been to university

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The economics of higher education model?

  • Schultz and Becker were the first to codify the economics of education, and won Nobel prizes

  • But very soon they took a wrong turning.

  • Neither realised that if HE leads to higher earnings of graduates vis a vis non graduates, as plainly it does, then it MUST lead to higher taxation.

  • Becker (1965) misled all subsequent economists in the field by focusing only on “rates of return” to the neglect of Net Present Values of private and public costs and benefits of education.

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Follies of Human Capital Theory Values

  • Business economists and engineers know the limitations of “internal rates of return”

  • In human capital theory reliance on IRR led to the following absurdities:

  • Primary education should have EXCLUSIVE priority over secondary and tertiary because primary IRR are higher than tertiary; and

  • Social rates of return EVERYWHERE lower than private IRR indicate universal subsidies from “the ghost in the machine”.

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More follies Values

  • Those believing that primary IRR higher than tertiary IRR proposed closing down universities in 3rd World countries, as the World Bank successfully insisted for many years, but have no understanding of calculus – and have contributed to the many failed states in Africa and the Pacific

  • In effect they believe we should all drive our cars always in first gear, where the rate of acceleration is ALWAYS higher than in top gear (read tertiary).

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More follies, cont. Values

  • Likewise the notion that because social IRR are allegedly always lower than private IRR, this dictates reducing subsidies to HE, is also a non sequitur.

  • How can it be that we are ALL worse off socially than we are privately from education? Internal rates of return are RATES not values;

  • And the NET PRESENT VALUES of the SAME flows of costs and benefits show the social NPV to be higher than the private NPV for most graduates.

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A new dawn for higher education? Values

  • If the day ever dawns when academic economists working on the economics of education understand the basics of the tax system and cost-benefit analysis, then the New Model presented here will surely be adopted.

  • But do not hold your breath! See my website

  • www.timcurtin.com

  • for my paper submitted to the Economic Journal explaining these last points in more detail.