Monday, October 30, 2006

Higher Education and the Savings Rate: A Unorthodox View

By Richard Vedder

Conventional wisdom holds that high college costs lead people to save more, to help them overcome rising postsecondary educational expenses. The proliferation of tax preferred college savings plans is evidence of this trend.

I am not so sure. Why, for example, has the national personal savings rate fallen dramatically over the past 30 years, precisely the period of sharply rising college costs? Taken by itself, this almost implies a negative relationship between college expenses and personal savings.

Some exploration of income and financial aid data in the latest newsletter suggests that people pay a significant marginal "tax" rate on their income in the form of reduced college financial assistance. If you save a lot and have a high income, you pay full tuition. Black students on average come from families with $25,000 less income than for the population as a whole (based on 2004 data), but receive almost $2,800 more in financial aid. For every dollar of added income above the $45,988 average earned by blacks, 11 cents less financial assistance was given by colleges (up to $71,000 in income). This is on top of conventional marginal tax rates of perhaps 30 or more percent. The high combined tax/reduced financial aid burden may be a significant deterrent to savings in the U.S., which, if true, has significant adverse macroeconomic implications for the nation. More and better data, for individuals, is needed to confirm this, but "need based" aid probably on balance is a deterrent to savings. Moreover, past savings lead to reductions in aid based on assets that go beyond the income-based determinants of aid discussed above.


superhiker said...

Here's another possible explanation: People are paying more for college. Perhaps this is money they would "saving" otherwise.

Absurdly, college payments are not counted as savings or investment. (I know, Richard Vedder and like-minded people may not think of college as an "investment", but most normal people do.)

TC said...

I think the "National Savings Rate" is a problematic standard of measurement. However, one can use a standard of measurement that is off by 10%, 20%... and so forth to use as a measure as long as it is applied consistently. Example; If you use a measuring tape with the first three inches of it missing to mark a board to cut at 58", you stretch out the measuring tape to 58", then stretch it out 3" more and make the cut mark at 61" to get a board 58" long. So while I don't really care for the "National Savings Rate", I don't care for measuring tapes missing 3".

From "BusinessWeek online" Jan. 2005:

"Yet the savings rate is a misleading measure of future economic performance. In today's economy, education and innovation are the main engines of wealth-producing growth, not physical capital. Yet the official statistics count spending on education and research and development as consumption, rather than as an investment.

That's a crucial distinction, since an outlay that is counted as investment ends up increasing savings. For example, if U.S. companies buy new capital equipment, that bolsters the U.S. savings rate. But if those same companies hire more scientists and boost R&D, that spending would not be counted as investment or add to savings, even though it would boost long-run growth.

It is more informative to look at what might be called the "hidden savings rate" -- the share of GDP devoted to education and R&D. By that measure, the U.S. far outperforms its major industrialized rivals. According to the latest data, the U.S. devotes 9.6% of its GDP to education and R&D. The next closest major countries are France and Canada, at 7.8% and 7.5%, respectively, followed by Germany and Japan. (TC Note: I would think the share of GDP devoted to education and R&D is a suspect number as well - think "efficiency and investment risk". In other words - it may take the US $9.60 to make $10, but it may only take Canada & Germany $7.80 to make $10.00. Make sense?)

So while other countries chide the U.S. for being profligate (fancy way of saying “recklessly wasteful”), Americans are putting more money into the things that matter over the long run. That's reflected in U.S. economic performance, among the strongest in the world. Both in the short run -- the past year -- and the long run -- the past 20 years -- the U.S. has had the fastest growth of the major industrialized countries.

Moreover, low personal savings has not stopped Americans from accumulating plenty of assets for retirement. Strong economic growth has lifted both housing and equity values. Over the past decade, for example, the NASDAQ is up 182% and Standard & Poor's 500-stock index is up 158%, far more than the London, Frankfurt, Paris, or Tokyo bourses. Over the same stretch, household net worth is up 67%, after adjusting for inflation and subtracting federal debt."

The point here is not the policy argument the BW author is making, but that the National Savings Rate has some holes in it.

If the national saving rate measures only cash out and does not consider the destination of the cash we have a small problem.

If Mr. & Mrs. Ben Dover take a portion of their income and put it in an IRA or mutual fund - that's counted as money spent.

Financial Advisors like to use the national savings rate as a selling tool - here's the scenario: The FA is seated with Mr. & Mrs. Ben Dover at the Dover's kitchen table. The FA pulls out a nice sheet of white paper and a fancy writing instrument. He draws a circle on it and begins to divide the circle into pieces of pie. The first piece of pie is a big one. The FA writes 32% in the piece of pie. The FA says, "Mr. & Mrs. Dover, on average, 36% of your income goes into taxes, FICA, Medicare, etc." Then the FA draws another piece of pie and writes 35% in it. He says, "Mr. & Mrs. Dover, this is the average share of income that goes towards insurance." Finally, the FA draws the last piece of pie and writes in 29%. The FA says, "now on average, this is the percent of income that it spent to pay expense such as mortgage, groceries, clothing etc."

"So", the FA says, "What is missing here?" Dumbfounded, Mr. & Mrs. Ben Dover just sit there like they were just lectured on Einstein's theory of special relativity.

"Well", says the FA, "Right now, our nation has a NEGAATIVE savings rate... That's right! With home equity loans and credit cards we are spending more then we are making and we are not saving for our future." (Pause, let them think, but not too long.) Then the FA says, "Would you agree, that if I can reduce your tax liability, restructure your insurance costs and reduce them, and help you establish a budget, we can turn this scenario around?" Ben Dover glances at his wife and says, "Hmmm, I don't know what to think." The FA says, "Okay then, if you agree that I can help you, let's get going so you can achieve financial independence as soon as possible."

Two poor dumb bastards just signed up for a financial plan with an estate analysis which is going to show them they are in deep sh_t.

The Financial Advisor works for Waddell & Reed and was escorted to my front door when he told me I didn't save any money.

So I guess that's why I don't like the use of the "National Savings Rate". But I understand your use of it. And I do agree that the average American is probably over-extended. That's what I keep reading.

Now you may be asking what in the world this has to do with "Higher Education and the Savings Rate: An Unorthodox view"? Well, I thought I'd have my say on the National Savings Rate and poor old Ben Dover.

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