College Can Be a Crapshoot

by Scott Burns

Does it pay to go to college?

That's a rude question, of course.

It's a question parents don't want to ask if they've just written the big checks. Nor do students want to ask it if they've just borrowed the money for their next semester.

At www.collegeboard.com, you'll find a reassuring study showing that education really does pay.

Without considering the intangibles, the study shows that each additional level of education draws a higher lifetime income.

While the median high school graduate age 25 and older earns $26,300, the median college graduate age 25 and older earns $42,200. That's an annual income premium of $15,500, or 59 percent.

Not bad, particularly when you consider that the difference also lets you avoid heavy lifting.

Yes, the college grad will spend years paying off her loans.

But eventually her earnings, net of loan payments, will pull ahead of the high school graduate's. So, case closed. It may hurt to write the checks or borrow, but college pays.

Right?

Well, maybe not.

According to the College Board, it takes 14 years before the college grad's income, net of loan payments, starts to beat what the high school grad earns.

During all those 14 years, college doesn't pay. High school pays.

But the real question is not which choice pays on an annual basis, but which choice pays on a lifetime basis.

Which choice permits a higher lifetime living standard? That's a question the board conveniently doesn't ask or answer.

Costs of borrowing

The answer depends on the costs of borrowing and the amount you need to cover.

Today's student loan rates are really high if you need to cover the full ride.

And the price tag for attending college is astronomical.

Over the last 50 years, for instance, the cost of going to MIT has increased about 20-fold. That calculates to an annual compound increase of about 6.2 percent, which, in turn, is about 2 percentage points a year higher than the 4.1 percent inflation rate over the same period.

That's a big difference when you compound it out for 50 years.

While you need $2,000 today to buy the amount of primo education that cost $100 only 50 years ago, you need just $745 today to buy the amount of consumer stuff that $100 bought 50 years ago. That's quite a difference – $2,000 vs. $745.

More important, few workers enjoy lifetime earnings increases that are 2 percent greater than inflation for their entire working lives. Most workers can consider themselves fortunate if their earnings rise 1 percent a year faster than inflation in the early years of their careers.

Don't think, by the way, that MIT is a special case. It isn't.

The cost of going there has risen pretty much in line with the cost of attending most private colleges and universities.

(You can't get a better education. My only regret about MIT is that I wish I had been mature enough to spend more time on campus learning and less time in places that dissolute Bostonians will remember fondly – the long-gone Palace, Golden Nugget and Jerome's in the Combat Zone.)

That said, the College Board approach to evaluating the economic value of a college education may overstate the benefits.

Consumption smoothing

If you take a consumption-smoothing approach, which you can do with financial planning software like ESPlanner, you can see how the cost of higher education interacts with factors like your lifetime taxes, Social Security benefits at retirement, loan repayments, etc. And you can do it all in dollars of constant purchasing power.

Economist Laurence J. Kotlikoff at Boston University, 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.

Using a combination of ESPlanner (the software he developed) and earnings figures used in the College Board study, Dr. 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.

Lifetime standard

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.

(You can, of course, improve things by attending a lower-cost public college or avoiding loans if your parents or grandparents pay the bill.)

If the same 18-year-old went straight to work from high school, her lifetime consumption standard would be about 10 percent 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, on average, even an expensive private college pays – but the lifetime gain in living standard is more like 10 percent, not 59 percent.

The hard part is the risk factor.

If college pays for the median-income worker, it may not pay as well for graduates who aren't so fortunate.

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: A degree from an expensive private college, heavily financed with debt, is a high-risk investment that, for many, won't pay.