Saturday, December 15, 2007

Harvard's Ten Percent Solution and the Alternatives

The announcement that Harvard College will henceforth charge students whose families earn between $120k and $180k per year only 10 percent of their annual income for tuition is surely a positive development. (Harvard is already free for students whose families earn less than $60k per year, and there is now a graduated scale up to the $120k.) Still, there is at least one possible oddity in the program and a deep question raised by it.

First, the oddity. Until now, Harvard has considered assets, including home equity, along with income, in determining financial aid eligibility. This is common practice among universities, but it has perverse effects. It rewards families that don't save for college by giving them extra aid relative to families with the same income that sacrificed the expensive lifestyle to save. Further, excluding just some assets from the calculation is easily manipulated. If, e.g., Harvard counts money in the bank but not home equity against aid eligibility, then families have an incentive to pay off their mortgages so as to transfer from a "counted" investment to an "uncounted" one. If (and I can't tell from just the press release), Harvard means to look ONLY at income, and not at assets at all, that solves this problem and also the problem of discouraging savings. It doesn't, however, deal with the fairness issues of charging low tuition to people with low income but, say, a large inheritance. Perhaps there's no way to construct a financial aid scheme that doesn't introduce distortions. I'm out of my depth here, but we might say this is merely the flipside of the taxation problem: Other than the idealized "lump-sum tax," there is no non-distorting tax, and the same could be true for financial aid, which is simply a negative tax.

Now the more fundamental issue. Maybe all university education should be funded by no up-front tuition but instead a commitments of a portion of future earnings. The meritocratic premises of selective admissions are that people of talent, regardless of financial means, should be encouraged to come to elite institutions so as to make the most of their talents. Loans and grants are a way to prevent unequal distributions of wealth in previous generations from distorting admissions in the current one. (Well, "prevent" is too strong a word, because the children of the wealthy have all sorts of other advantages that aid them in getting admitted, but let's put that issue aside.) Yet, nearly anyone who will graduate from Harvard (or other highly selective universities) is not without means: Some are without current means, but the Harvard (or comparable) degree that they will receive on graduation means that they will be able to earn a great deal of money at the back end. The problem is liquidating that now.

Loans are one possibility but they have the distorting effect of incentivizing talented children of poor parents to go into the most lucrative fields, rather than those that they find most interesting. Funded by loans, a brilliant poet ends up pursuing economics and then a career in management consulting to pay off the loans. A better way would be simply to tax the future income of all graduates. Thus, those who end up earning the most---and thereby gaining the greatest financial benefit from the university education---pay the most. One could even use progressive rates.

To be sure, this proposal has some difficulties, the largest being the phase-in problem. To avoid adverse selection---poets opt in; future investment bankers opt out---all students would need to pay this way, and thus universities could not charge anybody tuition, immediately upon going to this system. The universities would need an enormous pool of money to replace the revenue stream currently attributable to tuition, to cover costs for the 20 years or more it would take for this regime to become self-sustaining. (Well, maybe not. Perhaps students could be randomly assigned to either the tuition or the pay-later pool, but that would only blunt the start-up problem, not solve it.)

Another impact of such a switch might be to eliminate voluntary alumni giving. Alumni who must pay 2 percent (or whatever) of their annual salary to their college might well regard this not so much as a substitute for tuition as a substitute for charitable giving. Of course, setting the repayment tables correctly at the front end could make up for the loss in charitable giving, and very wealthy alumni might still be motivated to give by some combination of loyalty, altruism and egoism. You wouldn't get a building named after you just for paying your annual two percent. You'd need to make a voluntary gift on top of that.

There is also the problem of enforcement, although perhaps by having new students sign a release of all future tax returns upon matriculation, these could be overcome. In any event, the obstacles---especially the startup cost---probably make my program impractical, but in principle the program has key advantages over the current regime. So too, of course, does a system of completely government-funded university education for all who qualify, but that approach, which was the dominant model in nearly all of the world until recently, has been declining roughly simultaneously with the scaling back of the commitment to other aspects of the social democratic project in Western Europe and elsewhere. So bottom line: the new Harvard program is an excellent idea given the constraints our university finance system faces. Whether it can be done by universities with smaller endowments is doubtful.

Posted by Mike Dorf


LDP said...
This comment has been removed by the author.
LDP said...

Professor Dorf, an interesting analysis. One of your suggestions -- loans for all -- is the topic of a Yale Daily News opinion piece I wrote in March of 2006.

Tam Ho said...

This is an issue on which I have some personal experience. My sister was admitted last year both to Smith and MHC. My parents make just enough money, which, combined with their college savings for my sis, made her ineligible for need-based money. But my parents make nowhere near enough to afford/justify $45k/yr for an undergraduate education. Put another way, we considered the idea of my sister taking loans to cover what my parents couldn't, and didn't feel the debt could be justified based on the uncertainty over her future income and how onerous that debt would be to her.

Thus, I love the idea of repayment from future earnings, with the further stipuation (which I think you'd welcome) that payment obligations be steeply progressive relative to income.

And to further the tax analogy - the notion that an alumnus could be recognize based on very high repayments (even if they are mandatory) will promote the idea that it's an honor and a privilege to be more able than the next person to support society, which I tried to suggest to my colleagues when they complained about the "high" taxes they pay on their fat paychecks when we all started at the firm.

AF said...

A better solution would be to tax future income up to the point that tuition is paid for. Even from a strong redistributionist perspective, Harvard has no claim to a perpetual percentage of Bill Gates's income.

Incidentally, the federal Direct Loan Program achieves a similar result with its Income Contigent Repayment program, which makes monthly loan payments dependent on income and forgives the balance (over 25 years). However, the formula is such that only people with low incomes have their loans forgiven; even those with moderate incomes will end up having to pay off their loans in full. Similar programs with more generous formulas seem like the best avenue for financial aid reform.

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