The notion that education pays and that better education pays better is taken for granted by almost everyone. For college professors like me, this is a very convenient idea, providing a high and growing demand for our services.
Unfortunately, the facts seem to disagree. A recent study by economists Stacy Dale and Alan Krueger showed that going to more selective colleges and universities makes little difference to future income once one accounts for the underlying ability of the student. Their work confirms other studies that find no financial benefit to attending top-tier schools.
It's good to know that Harvard applicants can safely attend Boston University (my employer), and that better higher education doesn't pay better. But does higher education pay in the first place?
Not necessarily. Consider four equally talented 18-year-olds — Joe, Jill, Sue, and Matt. Joe takes a pass on attending college. Instead, he decides to become a plumber.
Jill chooses medicine. She goes to an expensive private college for four years, an expensive medical school for four years, does a low-paying internship for two years followed by a low-paying residency for one year, and finally, 11 years after high school, gets a real job, as a general practitioner.
Sue and Matt both get bachelor's degrees in education at the same expensive college Jill attends, but Matt spends an extra two years after college getting his master's.
All four of these hypothetical kids settle down in Ohio, remain single, and retire at 62. At age 50, the peak earnings year for all four, Joe, the plumber, makes $71,685 (in today's dollars). Sue, the teacher, makes $89,584. Matt, the teacher with the master's degree, makes $103,250. And Jill, the doctor, makes $185,895. All figures and others used in this analysis are based on earnings data by age, state and occupation.
Who ends up with the higher lifetime spending power, assuming Sue, Matt, and Jill had to borrow, at high prevailing interest rates, to pay tuition and cover living expenses while in school?
To answer this question, I used ESPlanner, my company's financial planning software. The program figures out, in two seconds, each kid's sustainable spending, taking account of educational costs, foregone earnings, annual federal and state income taxes, annual payroll taxes, Social Security benefits, and Medicare Part B premiums.
Jill, the doctor, has the highest living standard. She gets to spend $33,666 year in and year out from age 19 through 100 This is after paying all her taxes and Medicare Part B premiums. Age 100 is the maximum age to which the kids might live and, thus, must plan.
Come again? Only $33,666? That's a far cry from Jill's peak earnings of $185,895. Yes, but remember, Jill has only about 31 years of significant earnings to cover some 81 years of living. And when Jill works, she gets nailed by the taxman. At age 50, for example, Jill pays 36 percent of her earnings in federal and state income taxes and payroll taxes. Finally, Jill has a bucket load of student loans to repay at an assumed 5 percent real interest rate.
To add insult to Jill's injury, Joe the plumber's sustainable spending is almost as high — $33,243. All those grueling years of study, exams, late-night emergency calls, and Jill gets to spend a measly $423 more per year than a plumber.
What about Sue, the teacher? Sue has less spending power — $27,608 — than Joe.
And Matt, with his masters? His spending power is even lower than Sue's, at $26,503. Too bad he didn't run the numbers before sending in his graduate school application.
These examples are a far cry from an exhaustive study of the returns on investing in higher education. And they treat higher education as purely a financial investment and ignore its tremendous personal and social nonpecuniary rewards. Still, the examples present a big red flag for those who pursue higher education solely for the money. And they raise a major question about government policy that promotes higher education as the sure path to economic success.
Laurence Kotlikoff is professor of economics at Boston University, president of Economic Security Planning Inc. and author of "Jimmy Stewart Is Dead." © 2011 Bloomberg News