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That said, the College Board approach to evaluating the economic value of a college education may overstate the benefits. If you take a consumption-smoothing approach, which you can do with financial planning software such as ESPlanner, you can see how the cost of higher education interacts with factors like your lifetime taxes, Social Security benefits at retirement and loan repayments. And you can do it all in dollars of constant purchasing power.
Not-so-obvious impacts
Boston University economist Laurence J. Kotlikoff, the prime mover behind the consumption-smoothing software, examined the cost of borrowing to attend a private college. He found a number of factors reduce the actual economic benefit:- When you earn more money, you pay more taxes, and you pay at higher rates. One consequence is that the cost of repaying college loans rises because you have to pay more taxes to net enough cash to repay a dollar of original borrowing.
- When you earn more money, you'll also get less bang for your buck from Social Security. Lower-income workers receive a much higher benefit as a percentage of their earnings than higher-income workers because Social Security benefits are more progressive than the income tax.
- When you are eligible for Medicare, you'll be hit with the same progressivity. Starting this year, Medicare premiums are keyed to household income. So you'll pay more for the same benefits if you earn more by getting a college education.
- Forgoing four years of earning power while in college on borrowed money nearly evens the playing field.
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Using a combination of ESPlanner (the software he developed) and earnings figures used in the College Board study, Kotlikoff found that an 18-year-old who had to borrow her way through a private college would still benefit, but not by a whole lot.
Specifically, he found that an 18-year-old who elected to borrow about $40,000 a year for college would have a lifetime consumption standard of $21,033 a year. If the same 18-year-old decided to go straight to work from high school, her lifetime consumption standard would be about 10% lower, $19,068. This standard is the amount of money available for spending after all taxes, savings and fixed commitments such as college loans -- calculated not for 10 or 15 years but throughout life.
So, ignoring risk issues, college, even an expensive private college, pays -- but the lifetime living standard gain is more like 10% than 59%. (You can, of course, improve things by attending a lower-cost public college or avoiding loans if your parents or grandparents pay the bill.)
The hard part is the risk factor.
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If college pays for the median-income worker, it may not pay as well for graduates who aren't so fortunate. Worse, if you earn less than the median, the burden of your college loans will weigh very heavily. They could, in fact, exceed your earnings gain.
Bottom line: College, particularly an expensive private college, is a high-risk investment, which, for many, won't pay.
Questions about personal finance and investments may be e-mailed to scott@scottburns.com. Questions of general interest may be answered in future columns. More columns by Scott Burns can be found here.
Published Oct. 10, 2007
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