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Making the Grade: The Economics of Education Chief of Staff Retreat February 22-24, 2007 copies of this presentation can

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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Making the Grade: The Economics of Education Chief of Staff Retreat February 22-24, 2007 copies of this presentation can

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  1. 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

  2. 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

  3. 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

  4. 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.

  5. Starting compensation is 85% higher for degreed workers. Source: Statistical Abstract of the United States

  6. 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

  7. The likelihood of employment is 15 percentage points greater for degreed workers. Source: Statistical Abstract of the United States

  8. 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.

  9. 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

  10. 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

  11. 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

  12. 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

  13. 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

  14. 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

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

  16. 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

  17. 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

  18. 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%

  19. 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

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

  21. 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: $850,000 (in 2006$)

  22. 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

  23. 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.

  24. 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.

  25. 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.

  26. 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.

  27. 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.

  28. 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.

  29. 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.

  30. 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.

  31. 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.

  32. 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.

  33. 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.

  34. 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.

  35. 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.

  36. 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

  37. 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.

  38. 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.

  39. 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.

  40. 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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