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

1

Economic Impact of Higher Education – Understanding the

Value of Higher Education

November 13-15, 2005

copies of this presentation can be found atwww.business.duq.edu/faculty/davies

2

College Tuition (4-Year Private, $ per year)

$-

$5,000

$10,000

$15,000

$20,000

$25,000

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

College Tuition Consumer Prices

Growth in Tuition Over Time

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

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

3

College Tuition as % of Median Household Income (4-Year Private)

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

50.0%

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

Cost of Education Relative to Household Income


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

4

Sources of Benefits to Higher Education

Benefits of a college education vs. a high school education

1. Difference in entry-level wages.

2. Difference in the growth rates of wages over the course of a career.

3. Difference in the likelihoods of employment.

5

Difference in Entry-Level Wages

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

Starting salaries 42% higher for degreed workers

Average Earnings for 18-24 Year Olds (2002)

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

High School Diploma College Degree

6

Difference in Growth Rate of Wages


Salaries grow 1.1%-points faster for degreed workers

Average Annual Real Growth in Wages from Age 24 to Age 60

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%


7

Difference in Likelihoods of Employment


Likelihood of employment 15%-points greater for degreed workers

Likelihood of Employment (% of civilian, non-institutionalized population)

0%

10%

20%

30%

40%

50%

60%

70%

80%


8

Average Annual Earnings (2002)

EducationAverage Earnings

Probability of Employment

Expected Earnings

High School Diploma $37,680 60.3% $22,718College Degree $80,144 75.8% $60,730

Expected Earnings

(Earnings) (Probability of Employment) = Expected Earnings

9

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.

10

Compensation-Expense Comparison


Cumulative Expected Compensation less Tuition

-$80,000

-$60,000

-$40,000

-$20,000

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

18 19 20 21

Age

High School Graduate (2002) College Student (2002)

$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.

11




-$80,000

-$60,000

-$40,000

-$20,000

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

$140,000

18 19 20 21

AgeHigh School Graduate (2002) College Student (2002)


In 1977, difference was $45,000

12


-$500,000

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

$4,500,000

18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64

Age




Cumulative expected difference was $375,000 in

1977

Breakeven at age 28

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

13




-$500,000

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

$4,000,000

$4,500,000

18 20 22 24 26 28 30 32 34 36 38 40 42 44 46 48 50 52 54 56 58 60 62 64

Age


Cumulative expected difference is $2.3 million in

2005

Breakeven at age 25

14

Evaluating the Benefit of Higher Education

Three ways to evaluate the benefit of an investment

1. Breakeven Point

2. Internal Rate of Return

3. Net Present Value

15

Evaluating the Benefit of a College Education

Breakeven PointHow many years will it take to recoup investment?

ExampleInvest $10,000 and receive $1,000 each year for 20 years.Breakeven = 10 years

1977Cost of college plus lost compensation $63,000 (in 1977$)Benefit of college $375,000 (in 1977$)Breakeven: 11.4 years

2002Cost of college plus lost compensation $184,000 (in 2002$)Benefit of college $2.3 million (in 2002$)Breakeven: 9.1 years

16



Breakeven on Investment in College Education

8

9

10

11

12

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

Breakeven (years from first year of college)

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

17


Internal Rate of ReturnThe benefit represents what rate of return on the investment?

ExampleInvest $10,000 and receive $10,800 back one year in the future.IRR = 8%1977Cost 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%

2002Cost 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%

18

Real Internal Rate of Return on Tuition

13%

14%

15%

16%

17%

18%

19%1

97

7

19

78

19

79

19

80

19

81

19

82

19

83

19

84

19

85

19

86

19

87

19

88

19

89

19

90

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02



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

19



Average Rates of Return (1977 through 2002)

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%6

Mon

thC

Ds

20-Y

ear

Trea

sury

Bill

s

AA

A B

onds

BA

A B

onds

S&

P 5

00

DJI

A

NA

SD

AQ

Col

lege

Edu

catio

n

20


Net Present ValueThe net future benefit is equivalent to what lump-sum amount today?

ExampleGiving 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).1977Cost of college plus lost compensation $63,000 (in 1977$)Benefit of college $370,000 (in 1977$)Net Present Value: $163,000 (in 1977$)

$524,000 (in 2005$)2005Cost of college plus lost compensation $220,000 (in 2005$)Benefit of college $2.4 million (in 2005$)Net Present Value: $1,035,000 (in 2005$)

21



Net Present Value (2003$)

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,00019

77

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

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

22

These Estimates are Conservative

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.

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

23

Implications of Tuition as an Expense vs. Investment

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

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.

Reducing loan interest rates causes a reduction in liquidity.

24

4%

6%

8%

10%

12%

14%

16%

18%

2% 3% 4% 5% 6% 7% 8% 9% 10% 11%

Loan Interest Rate

Lo

an P

aym

ent

as %

of

Gro

ss I

nco

me

20-Year Loan (wage tax exempt)

Perceived Burden of Tuition Debt

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

Low

Pain

Mod

era

te

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

Hig

h P

ain

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

25

100% of Tuition & Related Fees Financed via Debt

4%

6%

8%

10%

12%

14%

16%

18%

2% 3% 4% 5% 6% 7% 8% 9% 10% 11%

Loan Interest Rate

Lo

an P

aym

ent

as %

of

Gro

ss I

nco

me

10-Year Loan 20-Year Loan

Low

Pain

Mod

era

te

Hig

h P

ain

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.

26


4%

6%

8%

10%

12%

14%

16%

18%

2% 3% 4% 5% 6% 7% 8% 9% 10% 11%

Loan Interest Rate

Lo

an P

aym

ent

as %

of

Gro

ss I

nco

me

10-Year Loan 10-Year Loan (wage tax exempt)

Low

Pain

Mod

era

te

Hig

h P

ain

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.

27


4%

6%

8%

10%

12%

14%

16%

18%

2% 3% 4% 5% 6% 7% 8% 9% 10% 11%

Loan Interest Rate

Lo

an P

aym

ent

as %

of

Gro

ss I

nco

me

10-Year Loan 20-Year Loan (wage tax exempt)

Low

Pain

Mod

era

te

Hig

h P

ain 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.

28

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.

29


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

30


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

31

Expected Wage Tax Revenue

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

Wage Tax Revenue Generated by a Student Over Course of Life (2003$)

StudentFederal

Income TaxState Income

TaxFICA Tax

(both halves)Total Tax Receipts

High School Graduate $159,000 $41,000 $217,000 $417,000College Graduate $605,000 $94,000 $458,000 $1,157,000Difference $446,000 $53,000 $241,000 $740,000

32

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.

Net Wage Tax Revenue Generated by a Student Over Life (2003$)

StudentTotal Tax Receipts

SS Retirement Benefits

Tax Receipts Less SS Benefits

High School Graduate $417,000 ($90,000) $327,000College Graduate $1,157,000 ($132,000) $1,025,000Difference $740,000 ($42,000) $698,000

33

Interesting Market EvolutionStudents 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

34

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%.

35

U.S. Net Exports as a Fraction of Total Net Exports

-60.0%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%R

oyal

ties

&Li

cens

e F

ees

Bus

ines

s,P

rofe

ssio

nal,

and

Tech

nica

l

Fin

anci

al S

ervi

ces

Edu

catio

n

Trav

el

Cap

ital G

oods

(non

-aut

omot

ive)

Tele

com

mun

icat

ion

Ser

vice

s

Foo

ds, F

eeds

, and

Bev

erag

es

Insu

ranc

eS

ervi

ces

Indu

stria

l Sup

plie

san

d M

ater

ials

Aut

omot

ive

Veh

icle

s, E

ngin

es,

and

Par

ts

Con

sum

er G

oods

(non

-foo

d, n

on-

auto

mot

ive)

Negative values indicate net imports


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

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.

36

Annual Growth in U.S. Net Exports

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%Te

leco

mm

unic

atio

nS

ervi

ces

Fin

anci

al S

ervi

ces

Bus

ines

s,P

rofe

ssio

nal,

and

Tech

nica

l

Trav

el

Roy

altie

s &

Lice

nse

Fee

s

Edu

catio

n

Foo

ds, F

eeds

, and

Bev

erag

es

Cap

ital G

oods

(non

-aut

omot

ive)

Aut

omot

ive

Veh

icle

s, E

ngin

es,

and

Par

ts

Indu

stria

l Sup

plie

san

d M

ater

ials

Con

sum

er G

oods

(non

-foo

d, n

on-

auto

mot

ive)

Insu

ranc

eS

ervi

ces

Negative values indicate net imports


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

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

37

Some Pending Legislation

Pending legislation falls (roughly) into three groups:

1. Legislation to control tuition or tuition growth.

2. Legislation to provide tuition tax incentives.

3. Legislation to provide tuition loan forgiveness.

38

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.

39

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.

40

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.

41

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.

42

Economic Impact of Higher Education – Understanding the

Value of Higher Education

November 13-15, 2005

copies of this presentation can be found atwww.business.duq.edu/faculty/davies

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

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