Transcript Document
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
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Tuition & Fees (4-Year Institutions, $ per year)
$25,000 $20,000 The cost of private college has increased 7.9% annually while consumer inflation has averaged only 4.4% annually.
$15,000 $10,000 $5,000 $ Private Consumer Prices 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 2
Tuition and Fees as % of Median Household Income
50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% The cost of one year’s college education has grown from 20% of household income in 1976 to almost 50% today.
4-Year Private Institutions Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 3
Benefits of a college education vs. a high school education 1. Difference in entry-level compensations.
2. Difference in the growth rates of wages over the course of a career.
3. Difference in the likelihoods of employment.
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Median Compensation for 18-24 Year Olds (2006)
$80,000 Starting compensation is 85% higher for degreed workers.
$70,000 $60,000 $50,000 $40,000 $30,000 $20,000 $10,000 $ High School Diploma College Degree Source: Statistical Abstract of the United States 5
Annual Real Growth in Median Wages from Age 24 to Age 65
1.4% 1.2% 1.0% 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.
0.8% 0.6% 0.4% 0.2% 0.0% High School Diploma Source: Statistical Abstract of the United States College Degree 6
Likelihood of Employment (1992-2006)
90% 80% The likelihood of employment is 15 percentage points greater for degreed workers.
70% 60% 50% 40% 30% 20% 10% 0% High School Diploma College Degree Source: Statistical Abstract of the United States 7
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.
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Cumulative Expected Compensation and Tuition (2006)
$100,000 $80,000 $60,000 $40,000 $20,000 $0 -$20,000 -$40,000 -$60,000 -$80,000 -$100,000 High school graduate enters workforce at age 18 and begins to accumulate earnings.
18 19 $180,000 difference by age 21 College student starts college education at age 18 and begins to accumulate debt.
20 21
Age
High School Graduate Private College Graduate Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 9
Cumulative Expected Compensation and Tuition (2006 vs. 1977)
$100,000 $80,000 $60,000 $40,000 $20,000 $0 -$20,000 -$40,000 -$60,000 -$80,000 -$100,000 18 19 In 1977, difference was $47,000 20 21
Age
HS Grad (2006) College Grad (2006) HS Grad (1977) College Grad (1977) Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 10
Lifetime Expected Compensation for 18 Year Olds in 1977 (2006$)
$4,500,000 $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 -$500,000 After finishing college, the college student’s earnings begin to outpace the high school graduate’s earnings.
In 1977, the cumulative expected difference was $1.1 million (in 2006$)
Age
High School Graduate College Graduate Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 11
$4,500,000 $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 -$500,000
Lifetime Expected Compensation for 18 Year Olds in 2006 (2006$)
By 2006, the lifetime expected payoff from a college education had grown 180% to $2 million.
Net of inflation and net of tuition increases
Age
$2 million High School Graduate College Graduate Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 12
$4,500,000 $4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0 -$500,000
Lifetime Expected Compensation for 18 Year Olds in 1977 and 2006 (2006$)
The bulk of the difference is due to the fact that a HS diploma has lost much of its value.
Age
HS Grad in 2006 College Grad in 2006 HS Grad in 1977 College Grad in 1977 Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 13
$4,000,000 $3,500,000 $3,000,000 $2,500,000 Lifetime earnings less tuition of college graduates rose $250,000.
Lifetime earnings of high school graduates declined $650,000.
$2,000,000 $1,500,000 $1,000,000 $500,000 $ HS Diploma in 1977 HS Diploma in 2006 College Degree in 1977 College Degree in 2006 Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 14
Three ways to evaluate the benefit of an investment 1. Breakeven Point 2. Internal Rate of Return 3. Net Present Value
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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 1977 (private college costs) Cost of college plus lost compensation Benefit of college degree vs. HS diploma Breakeven: 2006 (private college costs) Cost of college plus lost compensation Benefit of college degree vs. HS diploma Breakeven: $60,000 (in 1977$) $360,000 (in 1977$)
10 years
$220,000 (in 2006$) $2 million (in 2006$)
10 years
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Expected Breakeven on Education @ Age 18
11.0
10.5
10.0
9.5
9.0
8.5
8.0
7.5
7.0
The breakeven period on a college education has remained approximately 10 years despite increases in tuition.
Private College Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 17
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 (private college costs) Cost of college plus lost compensation Benefit of college degree vs. HS diploma Real rate of return (return less inflation): 2006 (private college costs) Cost of college plus lost compensation Benefit of college degree vs. HS diploma Real rate of return (return less inflation): $60,000 (in 1977$) $360,000 (in 1977$)
15%
$220,000 (in 2006$) $2 million (in 2006$)
16%
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Expected Real Return on Education @ Age 18 (2006$)
20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% The real rate of return (return less inflation) on a college education has remained approximately 16% despite increases in tuition.
Private College Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 19
30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0%
Average Nominal Rates of Return (1977 through 2006)
Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Annual Survey of Colleges , The College Board 20
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 (private college costs) Cost of college plus lost compensation Benefit of college degree vs. HS diploma Net Present Value: 2006 (private college costs) Cost of college plus lost compensation Benefit of college degree vs. HS diploma Net Present Value: $60,000 (in 1977$) $360,000 (in 1977$)
$500,000 (in 2006$)
$220,000 (in 2006$) $2 million (in 2006$)
$850,000 (in 2006$)
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Expected Net Present Value of Education @ Age 18 (2006$)
$1,000,000 $900,000 $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 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 22
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.
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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.
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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.
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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 $650,000 decline in the value of the high school diploma.
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Coincidence argument
As incomes rise, people who would earn more anyway now also are drawn to attend college.
One way to test this is to take people of the same inherent ability, put some in college, and some directly into the work force. If the coincidence argument is correct, then we should see no difference in earnings between the two groups.
Let the two groups be blacks and whites. Assume the same inherent ability.
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1.23
1.13
1.03
0.93
0.83
0.73
0.63
0.30
If the coincidence argument holds, we should observe no change in relative earnings between the two groups as relative college completion between the two groups changes.
0.35
0.40
0.45
0.50
0.55
0.60
College Completion Ratio (% Blacks / % Whites)
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0.71
0.70
0.69
In fact, we see a marked increase in relative earnings as the relative completion rate rises. This contradicts the coincidence argument.
0.68
0.67
0.66
0.65
0.64
y = 0.1855x + 0.5821
0.63
0.30
0.35
0.40
0.45
0.50
College Completion Ratio (% Blacks / % Whites)
0.55
Source: Current Population Survey, U.S. Census Bureau, Tables A-2 and A-3 .
0.60
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Do taxes impact the value of education?
A progressive tax structure diminishes the financial value of education by reducing the financial gain to holding a degree.
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26% 24% 22% 20% 18% 16% 14% 12% 10% 7.9% difference The tax structure causes college graduates to bear a greater tax burden.
9.7% difference HS Graduates College Graduates Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Congressional Budget Office.
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Expected Additional Lifetime Tax Burden from Obtaining a College Degree (NPV, 2005$)
$260,000 $240,000 $220,000 $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $ 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.
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Total Cost of Obtaining a College Degree (tuition plus additional tax burden) (NPV, 2005$)
$260,000 $240,000 $220,000 $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $ The additional tax burden of holding a college degree is currently three times the cost of four years’ tuition.
Expected Additional Tax Burden Tuition at 4-Year Private College Source: Statistical Abstract of the United States ; Current Population Reports , Bureau of Census; Congressional Budget Office.
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$4,000,000 $3,500,000 $3,000,000 $2,500,000 $2,000,000 $1,500,000 $1,000,000 $500,000 $0
Components of the Value of Higher Education (2006$) Total = $3.3 m.
Added Tax Burden
Added Value of Higher Education
+ $1.1 m.
– $150 k Total = $3.4 m.
Added Tax Burden – $250 k
Added Value of Higher Education
+ $2.0 m.
Value of Secondary Education
+ $2.3 m.
Value of Secondary Education
+ $1.7 m.
1977 2006
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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.
Liquidity pain points
• Amount of loan • Duration of loan • Interest rate Summarized in the monthly payment • Co-signer requirement 35
16%
Self-Reported Pain from Student Loan Payments (college graduates)
High Pain 12% Moderate Pain 8% Low Pain 4% 0% 0% 2% 4% 6% 8% 10% At typical student loan rates, students who are paying back loans report low levels of pain.
Loan Interest Rate
Median Student Debt After Private College Loan Interest Rate 12% Source: Trends in Student Aid , The College Board, 2005; College on Credit: How Borrowers Perceive their Education Debt , Nellie Mae Corporation, 2003 14% 36
Liquidity pain points
• Amount of loan • Duration of loan • Interest rate Summarized in the monthly payment • Co-signer requirement The survey suggests that co-signer requirements may be the source of perceived illiquidity.
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Since 1995, PLUS loans have grown 360% loans have grown over 1,000% .
while Alternative 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.
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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.
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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
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