The Three Heads of Education Funding

<STD: Serious Topic Disclaimer>

In the interest of offering content both didactic and accessible, the following Serious Topic will not include proper source support. This means you shouldn’t believe any of it. If you find the discussion compelling, however, I encourage you to pursue a more demonstrable truth.

Education spending is a controversial topic these days. Part of the reason for this, I think, is that much of the world handles higher learning differently than the United States. I think that education is one of the most valuable things a country can invest in—and that’s a strange position for a conservative like myself to take. But “education” isn’t the same as “university education,” and maybe it’s worth approaching the two differently.

I don’t intend to address the value of mandating education through the high school level (or through age 16, or whatever it is); let’s just assume that because everyone has to get a basic education, it makes sense for the government to fund the education system through tax revenue. I know, I know—this itself is highly debatable, but I think it’s wise to restrain ourselves from hyper-capitalist libertarian “there is no public good” arguments for the moment (even if I kind of like them). 

Back to the point. American university educations are very expensive. Of this I can personally attest; tacking on a J.D. to my B.A. is plunging me into impressive levels of debt, and this blog doesn’t pay the bills. My time spent studying in Europe was a lot cheaper. I also felt like the quality of education was a lot lower, but my anecdotal evidence shouldn’t be considered reliable in any way. No, I bring up Europe because of the first point: It’s cheap! A lot of European countries subsidize higher learning. Is that a good idea? What does it do from a policy perspective? These are the questions I’d like to address with this post.

There are a few ways to subsidize higher learning. A common misconception is that American universities aren’t subsidized, but that’s not true, because we use federally subsidized loans (anyone familiar with the acronym FAFSA has probably endured the horror that is the application process). We’ll be looking at three paradigms: general subsidies through tax revenue, subsidized loans, and a pure market-driven system. The most important thing to remember about this analysis is that the costs we’ll discuss come in different forms as well. If an education costs, say, $100,000, that money can go to the school through either of the three paradigms, but the method of payment doesn’t change the cost. Which paradigm is used, however does change the cost.

The market-based approach is, of course, the most efficient. If there are no subsidies, prospective students pick their schools based on a normal cost/benefit analysis, presumably. What school has the most to offer for its price? Of course, exactly what a given student it looking for—maybe it’s a great academic reputation, maybe it’s a lot of hot co-eds, maybe it’s a nice dining hall—will vary. But the analysis is fundamentally the same: Who gives me the best deal? It’s the same way we buy everything else—TVs, cars, appliances, food, etc., so the market works in the same way. We like the idea of car manufacturers operating in a relatively pure market because the competition drives down prices. Toyota could make the Prius cheaper by, say, removing standard air conditioning, but most people think A/C is worth the price. Dodge could make a solid platinum dashboard standard in its Chargers, but most people wouldn’t find that worth the price.

So basically, all car manufacturers are trying to give customers as much as they can for as low a price as possible, maximizing the value customers get for their purchase. This makes the winning dealership most profitable. It also motivates car manufacturers to invest in new technologies that make their cars more cost-effective and attractive to consumers. This is the classic case of market incentives driving progress.

Why should we think about education differently? If schools thought like car manufacturers (or most any other business venture), they would be motivated to maximize the quality of their institutions and reduce costs as much as possible. A school would do good cost/benefit analyses for each potential expense. Would spending money on a new gym be worth it? How about issuing grant money for a given project? The real cost of an upper-level education would be lowest under this system, and the average quality highest.

Well, there are a few reasons to doubt this approach in the context of education. Perhaps the most important is that, just as some people can’t afford a car (me, for instance), some people couldn’t afford education in a market environment. Is this a problem? Well, for reasons related to our ideas of social justice and fairness, maybe… but then again, maybe not. Access to the world of higher education would be denied to some on the somewhat arbitrary basis of wealth, but those with access would have it for the lowest possible cost, and the quality would be better. Besides, as we’ll see below, other payment paradigms create costs for other members of society—taxpayers, for instance—that may also constitute social injustice.

A better argument why the market-based approach is ineffective is that word economists hate: externalities. Excluding a sector of society from higher learning means that a sector of society will be perpetually less productive, and that’s a cost all of society bears. Even poverty produces potential, and losing that potential is a cost all of society bears. I saw an interesting interview with Harry Potter author J.K. Rowling recently; she was discussing what a good investment she had been for the U.K. welfare system. The thousands in welfare money they paid her turned into a treasury of tax revenue—any reasonable taxpayer would want his money spent on that investment. Of course, not all investments turn out so well, and it’s hard to weigh the costs and the returns, but it’s a valid consideration.

It’s also important to note that loans would still exist in the market-based system—just not federally subsidized ones. So even someone who couldn’t afford college could go to a bank and borrow money (if he could convince the bank to lend it). This is a nice built-in feature. The private sector is willing to assume the costs of performing cost/benefit analyses for loan applicants (“Will this person be able to pay us back? Is this degree worth its cost?”), all while expanding access to higher education.

A final reason the market-based approach might not be ideal: Academia isn’t profitable, but it is useful (sometimes). Universities do a lot of important research and a lot of unimportant research. Take, say, cancer research. I have absolutely no expertise in the field, but I have to imagine that a huge amount of money goes into cancer research—and that a lot of that money produces nothing profitable. But we all want universities to spend money on cancer research, because the boon to society of reducing or eliminating cancer’s negative effect on society is worth very high costs. Universities put at the mercy of an unforgiving market might be less willing to spend money such research, because it’s not likely to produce immediate returns and it’s very costly. The same goes for less important research, like the sort of projects that literature departments do. This sort of stuff has value for society, but creates very little appeal for a lot of students. Fidelity to the bottom line would have ill effects on, for example, the arts—and most of us probably want to live in a world where those things are nurtured, even at some price.

The counter-argument to this point is that there are students who value these things, and so they would value them in their cost/benefit analyses. Even if cancer research is expensive and brings universities little revenue, there are lots of students who want to do cancer research, and are prepared to pay to have access to it (so, in that sense, it does create revenue). Similarly, there are students who want access to the arts, and will pay for that. It’s easy to argue that this alleged “problem” is really just a more efficient allocation of resources that reflects different activities’ realistic value.

What about the different types of government subsidies? In many nations where the government pays for (at least a portion of) its citizens’ higher learning, this is considered a natural state service. We’ve already discussed why this approach is less efficient than the market approach, but because the ancillary benefits and costs aren’t always clear, it’s worth discussing subsidies. It’s perhaps a good idea to keep in mind that on the best-regarded lists of the best worldwide universities, the U.S. is always best-represented. This isn’t necessarily a product of the way those universities are financed, but it is suggestive, and offers us a useful reality to backdrop all of this theory.

Different approaches to subsidies are largely two sides of the same coin. Let’s compare them.

Heads: The government offers subsidized loans that are much easier to get than traditional bank loans. In other words, the government pays your way now, and then you pay the government over time with interest. The interest might be lower than market rates, and there might be forgiveness programs that absolve debtors of their obligations after a certain period of time—say, 20 years.

Tails: Universities receive national funding and students go for free (or for a significantly reduced tuition). Basically, schools are funded through tax dollars.

A common misconception is that these two approaches are meaningfully different. But both put the burden of paying for education largely on the same people. The former plan burdens students themselves—a lot. The upside is that the people paying for education are the ones getting it. And, while these students get hit with a big number (trust me, I empathize!), they pay it off slowly over a long period of time, making it manageable.

The latter plan spreads the burden across society in general, and everyone who pays taxes contributes. It’s easy to allow that cost to disappear into the pool of tax obligations that already exist, but the price is real. So instead of a comparatively small group of people paying a larger amount over a shorter period (students paying off their loans for a couple of decades), a larger population pays a smaller amount over a longer period (all taxpayers paying higher taxes for their entire taxpaying lifetimes).

For the average student, the actual cost might be the same. It’s hard to tell exactly how much anyone pays under either system, but we can do some fun hypothetical math. It’s guaranteed inaccurate, but it’s also guaranteed pretty close.

There are about 100 million people who actually pay income tax in the United States. The 200+ million people excluded from this number are those who don’t work (whether unemployed or just out of the job market) and those who make too little to be taxed. Anybody who plans to remain in this category for a lifetime decidedly benefits from the tax-based regime, as such a person would receive a heavily subsidized education at no cost.

But what about the average student? Most college grads should have sufficient income to pay taxes, right? (Well, maybe not, if they have a lot of dependents, but work with me here). The average yearly tuition at a 4-year public university is about $20,000; the average yearly tuition at a 4-year private nonprofit university is about $35,000. Financial aid programs schools have in place usually knock down the actual financial burden to students a bit, and not all students go to 4-year institutions, so let’s just stipulate the average annual cost to college students—including tuition and fees—is $15,000 (again, this isn’t totally accurate, but it’s guaranteed a large number of American students experience a real obligation around $15,000). There are about 20 million American college students.

So, we’ve done some rounding to get to easy numbers: 100 million, 20 million, and $15,000. Fortunately they’re all pretty close to right.

This means that the average cost of all American higher-level education for a year is about $300,000,000,000. Yeah, THREE HUNDRED BILLION DOLLARS. A lot of dough. Once again, it’s almost certainly not a perfect number, but it’s just as certainly giving us a better picture of the overall landscape than we’d have if we tried to break down all the complicating details right now.

So how does paying off $300 billion per year work under the subsidized systems? If we’re taxing, it’s pretty straightforward. It averages out to $3,000 per person. Of course if we’re continuing with our “average student” analysis, it isn’t fair to pin this on our guy without some analysis. Tax revenue comes by and large from the very wealthy. If we assume our average student makes a very respectable but not exorbitant income (let’s say, pursuant to our affection for easy numbers, $100,000 per year), he’d only be in about the 25^th percentile in terms of how much income tax he pays—despite being in the 85^th percentile or so in terms of how much income he makes.

Now, before we come up with a number, it’s important to issue the reminder that we use a progressive bracket-based tax scale here in the States. What I’m proposing is that if we started subsidizing higher learning directly through tax revenue, the percentage attached to that bracket might need to get bumped (naturally—we’re trying to come up with another $300 billion).

Under our current tax regime, the richest 5% of taxpayers would contribute close to $180 billion of the obligation; including the whole top 10% would move that bar to $210 billion. That means that the 10 million wealthiest taxpayers would average $21,000 a piece in contributions to subsidized education. In essence, each one would be paying to put some stranger through school!

Average Student would pay about $3,400—not far off from our $3,000 average. Average Student’s college pal Average Art Student, who now makes $32,000 per year (hey, I was a humanities major, I get it) will pay around $135.

You might be thinking, “Hey, it’s totally unreasonable to consider a $100,000 salary average for a newly-graduated college student!” And you’d be right, but we’re looking at a long-term analysis here, so he just has to average something like a $100,000 salary for all of his working years. Plenty of government jobs with professional qualifications a college student would have can take their holders over $100,000 at later ages, which we can assume is what Average did.

What if Average Student had taken out federally subsidized loans? Well, he’d have a total obligation of $60,000 (4 years at $15,000 each). If he paid that same $3,400 per year on average, he wouldn’t put much of a dent in that figure as interest compounded. He would have to pay more money up front, but would be rid of his obligation quicker (because this one you can actually pay off). We could fabricate interest rates and a payment schedule and work out the total obligation, but it should be pretty clear at this point that both systems create large obligations for those who pay—large enough obligations, in fact, that either system could be better for a prospective student, depending on his wealth.

(Note: I’m not going to go into depth on all the different types of loans, either: Federal Perkins Loans, Federal Direct Student Loans, Stafford Loans, etc. etc.—these are all variations on a theme, although each variation offers its own unique challenges).

So here’s the breakdown: If you’re poor, you want a tax subsidy program. You bear almost no burden, and garner tremendous benefit. A subsidized loan program (assuming you could get a loan) would leave you repaying your tuition and fees with interest, which would be much more expensive. If you’re rich, you prefer the subsidized loan program, because the tax burden you’ll face otherwise will be very high. The subsidized loans are a comparatively much smaller burden.

Great! Class warfare, right? Well, as with virtually any government program based on the redistribution of wealth, these systems have disparate impacts on different sectors on society (that’s the whole point). But keep in mind that even the poor pay taxes, and even if their obligations are lower, so are there needs. $21,000 is worth less to Warren Buffet than $150 is to someone living paycheck to paycheck. If this hypothetical poor person could opt out of the system, he might choose to do so, keeping the $150 and forgoing the subsidized degree. You could argue that this would be a sub-optimal move for him (probably convincingly!), or that the positive externalities of opening doors through the tax system are high, but he would have a point that he was poorly-positioned to subsidize others’ (even wealthy others’) educations.

Of course, one response to this dilemma might be just to tax the wealthy more and tax the poor still less. In fact, this is an increasingly popular solution to lots of things these days. What would the implications be?

Well, this would be a lot like the market system… in reverse. Universities would be disincentivized to spend money based on a reasonable cost/benefit analysis. What attracts students? Well, pretty campuses, generous accommodations, and lots of research money, among other things. Nice facilities, too: big swimming pools, huge gyms, tennis courts, etc.

All of those things are great, just like a Ferrari is great. But most people don’t buy Ferraris because they can’t afford them, and you can get perfectly effective cars that serve much the same purpose for a lot less. Now that school is funded through taxes, though, and everyone goes “for free,” they have no reason not to take the Ferrari.

…Well, if they were all a unique combination of smart, charitable, and civically-minded, they would opt to do a cost/benefit analysis anyway, and discourage unwise spending that would increase the net tax burden, but that wouldn’t happen. It would be a collective tragedy of the commons.

Let’s return to our example of the Prius with no A/C and the Dodge with the platinum dashboard. If we assume those two cars are identical in all ways, except 1) cost, and 2) the Prius has no A/C and no platinum dash and the Dodge has both of those things (I know, it’s not true in real life), most people, when faced with a choice between the two, would take the Prius. A dashboard made of platinum has to cost several million dollars—a premium far too great for the price of A/C. But if the government is just giving the cars away, nobody has any reason not to pick the Dodge—again, except that “giving away” really means “buying with taxpayer money,” and everyone taking a car is a taxpayer.

My undergraduate institution decided, during my senior year, to replace all of its buses with a more environmentally fleet. Admirable, certainly, but also very expensive. This move came at the same time that the school had to furlough its staff (my school was pretty broke). In a corporation, spending $9 million to replace a fleet of already-functional buses while corporate employees couldn’t even get their salaries would undoubtedly result in a derivative suit against the corporate managers. It would have much wiser to cut unnecessary costs and support the university’s basic functioning, but the motivation systems weren’t in place to encourage that plan of action.

The result is that education gets much more expensive. Even if students don’t get bills from their schools, they end up paying more in the long run for their degrees—they just do it through taxes or through loan payments. Schools just don’t have any reason to make their products competitive (or much less of a reason).

Of course, we could always just make the richest sectors of society pay for that effect. There’s not much to argue against this approach except that relying on a system of wealth redistribution that so strongly disincentivizes the acquisition of wealth is short-sighted and doomed for failure.

Then we could regulate spending—but this creates another problem. Funding and regulating universities essentially nationalizes them, and giving the government control of the marketplace for ideas seems less than ideal. Not only would regulations increase expenses, it would give the government a grip on free thought. At the risk of sounding like a conspiracy theorist, this is a terrible idea—both for the political implications and the threat to quality of education.

All of this is for your consideration. You’ve probably guessed that I prefer the market competition approach, but subsidized loans aren’t a terrible compromise, all things considered. Perhaps I’m alone in this, but I get a larger sense of civic satisfaction from paying off loans than from paying increased taxes—the thought of contributing to government subsidies while maintaining at least the semblance of a competitive market is preferable to just draining the wealthy and letting universities get complacent and fat. At some point we’ll have to collectively agree that efficiency is a public good, just like education and health.

And on the cold day in hell when we have that agreement, I’ll probably still be paying off my loans.