#9: Free College – Are you willing to pay for it?

Democratic candidates Bernie Sanders and Hillary Clinton are promoting universal free college.  This campaign promise is getting a lot of positive response for the obvious reason, as reported by the NY Times, that college tuition increased 439% from 1982 to 2008, while income increased only 147%.  These trends in tuition and income continue today.  I have a vague recollection that the tuition in 1982 at my Alma mater was around $6,500 per year.  The total cost to attend this same school in 2016-2017 is $68,728. Just three years ago it was $59,758.  Even at this cost, the school had over 29,000 applicants for approximately 1750 placements.  Also, reading recent reviews of students from 2014-2016, they unanimously agree that the quality of the education is “unparalleled”, “top-notch”, and “worth every penny”.  Basic microeconomics suggests that this school has plenty of upside to raise tuition even further until the number of applicants equals the number of placements.

What happens to the students who do not get accepted into this school?  Clearly they have other options.  Most probably have applied to other private universities, and have publicly-subsidized state universities as a back-up plan.  Of course, the tuition for state universities is also going up, causing some of these college-bound students to look at 2-year community colleges, where they can finish with an associate’s degree, or transfer to a 4-year school.  There are also college degree programs available online which offer additional price options for the high-school graduate.

The obvious point is that the post-secondary education industry in the United States is very mature and offers a wide range of price and quality with apparently low elasticity of demand.  This means that no matter how high the price of tuition goes, there are always more applicants than placements.

Why then is a campaign promise for free college tuition so appealing?  The answer is because in June, 2014 the total of U.S. student loan debt exceeded $1.2 trillion, and became the second leading category of debt, surpassed only by mortgage debt.  The average 2016 graduate has $37,172 in student loan debt, and that person is only one of 43 million in the U.S.  The impact of this much debt is that graduating students delay making decisions to purchase homes and start families.  Unlike other debts, student loan debts are not dischargeable in bankruptcy, except in special situations.  If you cannot pay your student loans back in your working lifetime, you could even lose some of your social security benefits when you retire.  The only true discharge from student loan debt is death.

Other countries offer free college tuition.  Germany, Chile, Finland, Norway, Sweden.  Shouldn’t the U.S. be able to do the same?  Yes, says Senator Sanders, especially if we tax the “Wall Street speculators”, those nameless, faceless monsters who received a bailout from the federal government in 2008.  Sounds nice in a campaign speech, but who are these evil speculators?  Anyone who trades stocks, bonds and derivative securities.

The Tax Policy Center analyzed the tax plan from Senator Sanders, which includes a Financial Transaction Tax which is 0.5% on stock sales, 0.1% on bond sales, and 0.005% on derivative contracts.  Sanders claims this will pay for his free tuition plan with $75 billion in tax revenues.  The fallacy in this proposal is the assumption that the volume of trades would not change when the new tax is imposed.  An analysis of this type of tax concludes that the revenue-maximizing tax rate is 0.34%.  Sanders’ rate of 0.5% would produce less revenue than expected as stock and bond traders would change their behavior and trade less often.

Evil stock and bond traders, however, are not the only targets of Sanders’ taxing scheme.  The red outline box in Table 2 represents his plan to increase income and capital gains taxes.  The lowest income tax bracket of 10% would increase to 12.2%, and anyone with capital gains in this tax bracket would pay a 2.2% tax.  At the other end of the income scale, the highest income tax bracket would increase from 39.6% to 54.2%, and capital gains tax would increase from 20% to 54.2%.

Sanders Tax Plan

On top of these new taxes would be a payroll tax of 6.2% to pay for universal Medicare, applied to all earnings like the current Medicare tax, and paid by “employers”.  We already know from my articles #5 and #6 that Medicare is underfunded by a factor of at least 2.  A payroll tax of 6.2% would only make the current Medicare system solvent, and not support any new beneficiaries.  Furthermore, the Sanders plan would increase the cost of employment and encourage employers to reduce staffing and hire more contractors.  For every employee paid $10 per hour, the cost of employment would increase from $10.76 to $11.38, not including unemployment insurance taxes.

At least Sanders understands that when he proposes that the federal government provide new benefits to the citizens, then the citizens have to pay the government more taxes to pay for these programs.  He is after all a democratic socialist.  Rather than rely on evil speculators to pay the cost of free college, let’s explore what it would cost if everyone, not just stock and bond traders, paid more taxes for this benefit.  You may be a teenager with a summer job, or parent or grandparent of small children.  Would you be willing to pay more taxes if you or your child is going to get a tuition subsidy from the federal government? How much would each person have to pay to make this benefit available universally?

Let’s assume first that the free tuition benefit is going to be equal to the average cost of in-state tuition at a public university.  Every graduating high school sAverage Cost of Collegeenior, all 4 million per year, would get this benefit.  They could use it go to any university, public or private that they want to attend.  This table shows the average cost to attend different types of colleges.  For this article, I am going to include the cost of housing and books as part of the analysis.  Also, let’s call the proposed federal benefit the Universal College Subsidy (UCS).

Next, we assume that the rate of inflation for college is 3.5% per year.  Allowing for 10% for administrative costs, and another 10% for waste, fraud and abuse (this is a federal program), then we can estimate the total cost of providing the UCS from 2016 through 2035, as shown in the following table.

Total Cost of Free College

How much tax would everyone have to pay in order to cover free college costs of $437 billion in 2016-17 to $828 billion in 2034-35?  We know from Obama’s 2017 budget that the Social Security payroll tax of 12.4% on earnings is expected to produce $798 billion in 2016.  This suggests that a payroll tax of 6.8% would be required to produce $437 billion in 2016 to pay for the UCS benefit.

Would this be a good deal for any child born in the year 2000 or later?  Based on the median earnings of a college graduate of $56,700 per year, the tax paid over a 40-year career for free college tuition at the payroll tax rate of 6.8% would be approximately $154,224, compared to a benefit in 2016 dollars of $90,940. For a single-earner household with 2 or more children, this would be a very good deal.

Free College Bar Chart

Let’s not forget, however, the 43 million Americans who are already carrying $1.3 trillion in student loan debt.  They would be paying this tax also on top of trying to pay off their student loans.  This is definitely a horrible deal for them.  However, increasing the free college payroll tax rate from 6.8% to 8.0% would raise over $1 trillion in ten years.  This additional revenue could be used to pay off existing student loan debt.  Once all student loans are paid off by 2030 or so under this plan, the tax rate could drop back to 6.8% or less in order to continue the UCS benefit plan for each new class of graduating high school students.

Free College Bar Chart with Student Loan Payoff

Looking at your personal paycheck is where the rubber meets the road.  This table illustrates what the impact would be for most wage earners paying an additional 8.0% of their wages for the free college benefit plan.  Considering that the low wage earner would be able to give their children an opportunity to go to college that he/she might not otherwise be able to afford, this appears to be an appealing plan.  The high wage earner would be able to take the same benefit and subsidize college expenses at the college of choice for his/her children.  At this same time, the person carrying student loan debt could support this plan knowing that they are also part of the national investment in college education.

I choose in this example to show the 8% free college tax being paid by the employee.  Politicians might try to shift half of this cost to employers in order to facilitate passage of the law.  I could justify splitting this cost between employer and employee by arguing that employers are investing in a better educated workforce.

Net Pay with Free College

If the federal government is going to administer a universal college subsidy, we have to ask the question, is there a place for every student to attend college.  According to the Department of Education statistics, 65.9% of graduating high school students began college the following semester.  In the fall, 2015, total attendance is American colleges and universities totaled approximately 20.2 million.  Thus, while one third of graduating high school students may defer matriculation into college, it seems that there is sufficient capacity to support universal college subsidies for American students.

What unintended consequences would appear with the UCS?  I expect that in the elite private colleges you would see the cost of attending rise quickly by the amount of the subsidy, as long as the number of applications far exceeds the number of placements.  The best way to minimize future tuition inflation is for the federal government to stop guaranteeing student loans.  Even with the UCS, students may still choose to borrow money in order to attend the college of their choice.  However, government guaranteed student loans tend to give license to institutions to increase their tuition annually.

Nevertheless, I can see that there could a positive benefit to providing the UCS benefit, particularly for families who currently do not have the ability to save for college.  This program could give a lot of Americans hope for a better future for their children.  Many details would have to be worked out, but in my opinion, a UCS program which includes an existing student loan payoff program must include the following conditions:

  1. No more federally guaranteed student loans.
  2. Available only to American citizens.
  3. Does not add to the national debt.
  4. Students are allowed to use the benefit for any qualified expenses as they see fit. A student admitted to a private school could use the entire benefit for tuition, and pay for his/her own housing and books.  Another student may use less for tuition, and apply the unused funds to rent.
  5. Allows students to defer use of the benefits up to 10 years.
  6. Supports education in trade programs as well as colleges.
  7. Congress cannot use funds in a UCS trust fund to pay for any appropriated or other mandatory expenses by issuing a government bond to the trust.
  8. The federal government does not use UCS to interfere with admissions and education standards of American colleges. Let the market forces produce innovation in post-secondary education.
  9. Nor should the federal government interfere with degree selection by students.
  10. Graduated students in the student loan payoff program must have a full-time job in order to get this benefit.
  11. Once all student loans are repaid, the tax rate drops to a level which supports the continuing UCS benefits.

Should we Americans support this UCS benefit?

Article 1, section 8 of the Constitution gives the power to Congress to “lay and collect Taxes… for the… general Welfare of the United States.”  Presumably, if tested, the Supreme Court would find the UCS constitutional in the same way Social Security and Medicare are constitutional.

Does it promote the general welfare of the United States?  It seems obvious that it would promote the general welfare as the educational level of the average citizen increases through this benefit.  Let’s think about this, however, a little more carefully.

As of August, 2016, Hillary Clinton is leading in the polls for the presidency of the United States.  Let’s assume that she wins, takes office in 2017, and is able to pass and sign the UCS bill in 2017. Starting in 2018, the federal government gives every future high school student an account equal to the average cost of in-state tuition, housing and books in order to purchase a college education.  This is the lowest end of the price range for college in today’s world.  How soon would we witness the labeling or establishment of “Clinton” colleges, which offer the minimum educational standard?  How many unqualified “professors” would enter the college market to skim off the system without advancing the education of their students, or facing termination due to low student ratings?  How quickly would the value of a college education deteriorate as we pursue an ideal of free college for everyone?

If you think this would never happen, I ask you to do a simple thought experiment.  Let’s say for example that there was also political support for a universal car subsidy, based on the ideal that everyone has “a right” to transportation.  A bill is passed, and President Clinton signs the bill to tax all workers enough money so that the federal government could guarantee everyone $400 per month to make a car payment, as well as buy gas and insurance.  Anyone could use this monthly benefit to buy any car on the market, even more expensive cars if they can afford the difference.  Within a short period of time, I believe we would see a “Clinton” car come onto the market.  The “Clinton” car would be a bare-bones car designed and priced to buy at the level of the subsidy.  It would be a poor quality car with limited color options and no special features.  It would have virtually no resale value, because everyone could buy a new one with their benefit.  Within 10 years, the country would be littered with abandoned, useless “Clinton” cars.

Would “Clinton” colleges produce useless college graduates?  Some colleges are not doing a very good job educating students even now, but we still have a college industry now which is largely free now, except for the price distortions caused by government-guaranteed loans.  Even though no one likes paying tuition at today’s rates, moving to a UCS benefit could destroy or greatly diminish the current standards of the American system.  Is this a price we are willing to pay for free college?

Finally, there is this to consider about a new tax to provide the UCS:

I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle. 

-Winston Churchill

 

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2 thoughts on “#9: Free College – Are you willing to pay for it?

  1. Another fine article. “Free” college would become like a high school education…..nobody appreciates something
    when they have nothing invested. Online schools are the answer, that’s where the Chinese are investing.Also,
    a two year mandatory military service would solve several issues (think Israel)

    Liked by 1 person

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