Thursday, July 15, 2010

A Graduation Tax in the UK?

by Daniel L. Bennett

The distressed UK government is considering imposing a so-called graduation tax rather than asking students to pay a higher tuition, as Business Secretary Vince Cable describes in the video below.
According to Cable:
students would "almost certainly" have to pay more, and called for a "radical re-think" of how universities are funded.

This would mean students repaying their tuition costs through taxation, once they started working, with higher earners paying more.

By linking the graduate repayment mechanism to earnings, it may be possible to establish a system where low earners would pay the same or less than they do now, and high earners would pay more.

There was a need to develop a university funding model based on the idea of less public support and greater contribution from those who benefit the most from it.
The proposed tax is a deferred payment (student loan) imposed at the point of payroll when a student has entered the labor force, and not a tax on all taxpayers. A graduation tax is theoretically similar to an idea that CCAP has been giving some thought to recently. Milton Friedman and Simon Kuznets originally proposed that college students be allowed to enter human capital contracts, or sell equity in themselves. Essentially, students would agree to repay a certain portion of his/her income for X number of years in exchange for the opportunity to attend college and hopefully, receive a degree and improve his career prospects. Dr. Vedder wrote a piece for the Chronicle of Higher Education recently discussing the idea. I’m not sure if we are for them or against them, but it is certainly an intriguing idea.

A “graduation tax” is in theory, similar to the concept of a human capital contract. One argument against such a tax would be that it is similar to indentured servitude –we provide you with this service (education) and in return you agree to provide us with X amount of your earnings for Y number of years. After that, you are free to do as you please. Framing the tax in these terms would likely draw strong political opposition.

Perhaps a stronger argument against it would be that any such financial arrangement should not be a function of an inefficient bureaucratic government that forces all students into a contract that many would not likely voluntarily enter into.

Such a “tax” is also likely to be highly progressive in that it benefits those students who will go into low-paying careers, while it punishes those who go on to high paying ones. In the case of the latter and those in middle and upper middle-income tracks, they would likely have preferred to take out a fixed-repayment debt (bond) to pay higher tuition than to sell equity in themselves. I think that most students are aware of their earnings potential while in college and it likely shows by what fields they choose to study (e.g. – business and engineering majors are likely to earn more than humanities majors).

As Cable indicated, the UK tax would be highly progressive. One possible unintended consequence of this could be that those with the greatest potential will opt out of college altogether, or drop out early in favor of entering the workforce (or starting up a company). This strategy worked quite well for folks like Bill Gates, Michael Dell and Mark Zuckerberg. It may also create a disincentive for graduates to work more or take promotion, as the tax burden will rise with earnings.

The highly progressive tax will also make it less likely that wealthy graduates will extend their philanthropic gifts to universities if they are already paying significant taxes to cover the costs of their education, which may or may not have contributed to their success. I think this may be the biggest unintended consequence of the tax, as private philanthropy is a significant source of finance in the U.S. and most of the rest of the world is trying to figure out how to tap such resources. The answer to this isn’t all that complicated – it is all in the incentives. Lower tax rates and/or provide an incentive for individuals to donate to private, non-profit causes, including universities, and people will be more likely to do so. Imposing a mandatory graduation tax that is highly progressive will all but kill philanthropy as a source of finance for colleges.

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