Tuesday, January 16, 2007

New College Tuition Initiatives And the Savings Rate

By Richard Vedder

The "in" thing this year is for high quality colleges to announce they are ending tuition fees for low income students. Many of the prestige Ivies have done this, along with some other high quality privates (e.g., Emory University) as well as flagship public universities (e.g., the University of Washington). In general, I have applauded this, although if this is done in a revenue neutral fashion, this means even greater tuition for the non-poor students, and a greater divergence between the sticker price and the actual average tuition paid. In other words, more price discrimination. The "end tuition" movement in the long run makes colleges more affordable to students collectively only if real cost-cutting is instituted, and I have seen little evidence that that is happening.

There are also some severe unintended economic consequences of this trend. Universities are, in effect, imposing a private marginal tax on income and wealth, and a tax that is of consequential magnitude. Suppose a family with a $50,000 income sends a child to a prestigious school and pays no tuition fees. Suppose a family with a $100,000 income sends their child to the same institution and is expected to pay $30,000 in fees. The family, in effect, is paying the equivalent of a 60 percent tax on the difference between $50,000 and $100,000 in income, which, in addition to state and local income taxes of perhaps 35 percent, reduces the family's effective tax rate on that income to 95 percent (assuming non-deductibility of tuition fees), removing almost all incentives to work and earn. Suppose the $100,000 income family derives its income from two spouses each earning $50,000. If one spouses simply quits work, the family foregoes only about $2,500 in disposable spending a year, since income taxes fall by about $17,500 and college tuition bills by $30,000. While this example probably exaggerates somewhat the true typical dimension of the problem, it is nonetheless substantial. College price discrimination policies impose significant disincentive effects to work and save in American society.

The question then becomes, "why work hard to save to send kids to college?" The national personal savings rate is extremely low, and although the official statistics probably understate the true savings of Americans, the true rate is no doubt very low, and probably has been lowered over the past generation by the increased price discrimination of universities.

The truly rich schools can and should simply end tuition for all. Harvard, Yale and Princeton, for example, all earn at least $75,000 in endowment income for every student, including graduate and professional students. With other private gifts and government grants, total non-tuition income per student far exceeds $100,000. This is several times the national average spending per student. If Berea College, Coopers Union and the service academies can be tuition free, so can Harvard, Yale and Princeton. The reason they are not is that these schools do not want to engage in a modest amount of belt-tightening that such policies would entail, and do not want to end the explosion in the salaries of their most prominent faculty and administrators that has gone on in recent years. Rent-seeking behavior trumps access issues or the national interest.

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