The notion that education pays and that better education pays better is taken for granted by almost everyone. For college professors like me, this is a very convenient idea, providing a high and growing demand for our services.
Unfortunately, the facts seem to disagree. A recent study by economists Stacy Dale and Alan Krueger showed that going to more selective colleges and universities makes little difference to future income once one accounts for the underlying ability of the student. Their work confirms other studies that find no financial benefit to attending top-tier schools.
It’s good to know that Harvard applicants can safely attend Boston University (my employer), and that "better" higher education doesn’t pay better. But does higher education pay in the first place?
The answer seems obvious. On average, doctorate holders earn more than those with master degrees, who earn more than those with bachelor degrees, who earn more than high school graduates. How can education not pay?
The answer is that education isn’t free. Top undergraduate programs are now charging students $50,000 a year to eat, sleep and, hopefully, attend class. But that’s just the direct cost. Education’s hidden cost is the time spent learning rather than earning.
Making School Pay
For education to pay it has to cover all its costs. It also has to make up for the progressive income tax, which taxes annual earnings, not lifetime earnings. If person A earns the same amount over her lifetime as person B, but does so in fewer years, A’s annual earnings, in the years she works, will be higher than B’s. This compressing of lifetime earnings into fewer years can potentially land person A in higher tax brackets during her working years.
Social Security’s payroll tax cuts the other way. It’s regressive, thanks to its ceiling on taxable income. Earnings bunching can lower lifetime payroll taxes provided the bunching pushes annual earnings above the ceiling, now at $106,800.
Social Security’s benefits formula provides no reward for paying taxes early. This too helps those who stay in school and start their careers late. On the other hand, the formula doesn’t credit earnings above the ceiling, which can penalize the better educated.
But what’s the bottom line? Does education pay?
Not necessarily. Consider four equally talented 18 year- olds -- Joe, Jill, Sue, and Matt. Joe takes a pass on attending college. Instead, he decides to become a plumber.
Jill chooses medicine. She goes to an expensive private college for four years, an expensive medical school for four years, does a low-paying internship for two years followed by a low-paying residency for one year, and finally, 11 years after high school, gets a real job, as a general practitioner.
Sue and Matt both get bachelor’s degrees in education at the same expensive college Jill attends, but Matt spends an extra two years after college getting his masters.
All four of these hypothetical kids settle down in Ohio, remain single, and retire at 62. At age 50, the peak earnings year for all four, Joe, the plumber, makes $71,685 (in today’s dollars). Sue, the teacher, makes $89,584. Matt, the teacher with the master degree, makes $103,250. And Jill, the doctor, makes $185,895. All figures and others used in this analysis are based on earnings data by age, state and occupation.
Who ends up with the higher lifetime spending power assuming Sue, Matt, and Jill had to borrow, at high prevailing interest rates, to pay tuition and cover living expenses while in school?
To answer this question, I used ESPlanner, my company’s financial planning software. The program figures out, in two seconds, each kid’s sustainable spending, taking account of educational costs, foregone earnings, annual federal and state income taxes, annual payroll taxes, Social Security benefits, and Medicare Part B premiums.
Jill, the doctor, has the highest living standard. She gets to spend $33,666 year in and year out from age 19 through 100 This is after paying all her taxes and Medicare Part B premiums. Age 100 is the maximum age to which the kids might live and, thus, must plan.
Come again? Only $33,666? That’s a far cry from Jill’s peak earnings of $185,895. Yes, but remember, Jill has only about 31 years of significant earnings to cover some 81 years of living. And when Jill works, she gets nailed by the taxman. At age 50, for example, Jill pays 36 percent of her earnings in federal and state income taxes and payroll taxes.
Finally, Jill has a bucket load of student loans to repay at an assumed 5 percent real interest rate, which exceeds the assumed 3 percent real return she can safely earn on her savings.
To add insult to Jill’s injury, Joe the plumber’s sustainable spending is almost as high -- $33,243. All those grueling years of study, exams, late-night emergency calls, and Jill gets to spend a measly $423 more per year than a plumber.
What about Sue, the teacher? Sue has less spending power -- $27,608 -- than Joe.
And Matt, with his masters? His spending power is even lower than Sue’s, at $26,503. Too bad he didn’t run the numbers before sending in his graduate-school application.
These examples are a far cry from an exhaustive study of the returns on investing in higher education. And they treat higher education as purely a financial investment and ignore its tremendous personal and social non-pecuniary rewards. Still, the examples present a big red flag for those who pursue higher education solely for the money. And they raise a major question about government policy that promotes higher education as the sure path to economic success.
To contact the writers of this column: Laurence Kotlikoff at firstname.lastname@example.org;
To contact the editor responsible for this column: James Greiff at email@example.com