A Great Debate, Part II: “The Trouble with Pay It Forward, Pay It Back”

December 6th, 2013 | Economic Opportunity Institute

Mike Konczal

By Mike Konczal, a fellow with the Roosevelt Institute, where he works on financial reform, unemployment and inequality.

This post is part two of a three-part debate of Pay It Forward that recently appeared on City University’s Graduate Advocate between bloggers Matt Bruenig and Mike Konczal. Read part one here.

In his 1975 collection of essays There’s No Such Thing As a Free Lunch, the libertarian economist Milton Friedman wrote: “I believe one of the great scandals in the United States is government subsidization of higher schooling. There is no other policy I know of which so clearly and on so large a scale imposes costs on low-income people to provide subsidies to high-income people.” In the short-run his solution was to advance tuition and government-provided student loans to replace public funding of higher education, while in the long-run create a system where students could sell contracts on their future human capital, pledging a percentage of their future labor in order to receive an education.

We are now in the long-run. Friedman at the time applauded a Yale law school that was attempting a human capital contracting provisioning, even though the Yale program was cancelled shortly afterwards due to alumni protests. But the idea lives on in recent actions by Oregon’s state assembly and in Matt Bruenig’s essay here. Though the purpose is noble, four major issues exist with these kinds of Pay-It-Forward plans that require close scrutiny.

Bruenig’s Proposal

But first, an examination of Bruenig’s proposal is in order. Bruenig argues that the government should levy a special income tax on college graduates and only use this funding to pay for higher education. So, say, a special 3 percentage income tax if you attend college, with no other state funding should be provided.

It’s not clear how Bruenig’s proposal would work. Would it apply to all schools, public or private? What about private schools that decided to not participate, as Yale law students did in the 1970s, or wanted to charge a higher rate? How much pressure should the state apply in that case? Do we want the IRS to enforce payments to private, and even for-profit, companies? How would funding be allocated–would it ignore the complicated cross-subsidization that happens among different tiers of state-level universities? Is this meant to federalize how the state systems are run, where the IRS and the Department of Education make choices for the states?

Putting aside the major implementation issues, there’s a significant problem in Bruenig’s argument, so central I wasn’t sure if I had missed something. Bruenig says: “The only difference is that under IBR, the disproportionately poor non-beneficiaries of free higher education are exempted from the tax. That’s it.” (Emphasis in original.)

This is wrong. Rich people who don’t participate in higher educationalso would not contribute. Upper-middle class people who only have a high-school diploma wouldn’t contribute either. Other revenues, like inheritance taxes, corporate taxes, taxes on capital and dividend income, and so on, would not contribute towards funding higher education, either at the state or federal level. The argument needs to extend to why asking a wealthy person who inherited a fortune and preferred not to go to higher education should be exempt from contributing to a system of accessible and quality higher education as a matter of fairness. This argument isn’t addressed.

Taking his solution as a more conceptual level, Bruenig is arguing that public higher education should be paid for only by those who attend it. Why? His argument hangs mostly on distributional issues–it is unfair to ask the poor to pay for higher education when they are the least likely to benefit from it.

Bruenig is confusing two different issues. The first is what role the government versus the market should play in the creation and allocation of certain goods, and the second is how much of the tax burden should fall on the poor. The morality of the second issue is being used to carry the weight of the first, but there really isn’t a conflict here.

It is perfectly fine to say that the government should use its powers to provide generous public goods while also using the tax code to fight poverty.  Exempting the poor from taxes has a long history. The French political economist François Véron Duverger de Forbonnais argued in 1758 that “the physical subsistence of every family is a privileged part of all income. Only the surplus above this minimum can be assigned to the public for the support of government.” Conversely, one could imagine a minimal state, with no role in education or anything else, that funds its very limited role through the most regressive of head taxes that fall on the poor.

The real question with fairness is how you ask someone who is doing ok, who didn’t attend higher education, to pay for public higher education? Or how do you ask a corporation, or an inheritance trust, to pay for public higher education? Which is to say, what interest doesthe public have in the issue, rather than using a plan like Pay-It-Forward to have individuals pay their education themselves? Four issues jump out.

A Public Good

A well-educated society boosts the material well-being of everyone. All the parts of the economic system, be they entrepreneurs, capital-holders, other workers in both the high and low end labor force, benefit from a stronger and growing economy that comes with substantial investments in its citizens.

I use the term public good not because of the strict definition of such a thing, but to emphasize the public in the good. One of the main reasons we’ve invested so much in a system is to explicitly not allow how much or on what terms access to higher education be left to a narrow band of elites or to the vagaries of the capital markets. As the historian Earle D. Ross argued about the 1862 Morrill Act, when it came to public higher education we were creating “real people’s colleges—with all their limitations a distinct native product and the fullest expression of democracy in higher education.” The median person in the country will attend an institution of higher learning at some point in their lives, so this is a question that impacts the majority of citizens.

To the narrow point, the fact that higher education does make the economy more productive as a whole means that the country as a whole has a stake in funding it. Even people who don’t attend benefit, and as such they should contribute. Bruenig’s argument seems to be predicated on the idea of “horizontal equity,” or the idea that it’s unfair to make someone who didn’t go to college contribute. This presumes that the distribution of incomes is a natural thing, existing outside the government and the services it provides, and shouldn’t be touched. But this isn’t true when it comes to the government providing mass higher education. Part of our substantial wealth has come from the resources we’ve put towards educating our citizens, a process that has made all parts, whether they’ve directly participated or not, of the economy stronger.

Adverse Selection and Substandard Institutions

Arguments like Bruenig’s seem predicated on the idea that the cash-flows will largely lineup the same way, with money either through taxes or through equity claims largely cancelling out. But ever since the pioneering work of Gøsta Esping-Andersen on welfare states, we should find an analysis that just looks at the amount of spending to be insufficient. (After all, the United States spends far more on healthcare than England; should we assume ours is a more generous and egalitarian system?) So what kind of institutions will we create?

Let’s assume someone wants to take a class at a local community college for fun, that they are happy to pay for. Will they be forced to pay a percentage of all their future income in order to do this? If not, if there’s a cash-out option, you’ve immediately introduced the concept of adverse selection at the local level. Meanwhile private and for-profits will strategically reformulate themselves to best target those who expect to have well-remunerated careers, to peel them off of public higher education.

What is adverse selection here? If you have the option of paying cash upfront or a percentage of your income, people who expect to have high incomes will take the cash option. There’s a strong likelihood that revenues will come in under projection.

It is highly unlikely such a scheme would go forward without some sort of cash-out option, unless we are comfortable destroying the subtle ways higher education benefits society, or if we want to cut off people’s ability to “try” higher education without becoming entangled in a life-long equity contract. Though this system would work fine for those who go straight through and graduate, it’s not clear how it would work for those with weaker attachments. As such we’d be encouraging people who expect to have high incomes, or people who aren’t sure about higher-education, to leave the public system.

If part of the goal of higher education is to collapse the difference between elite education and mass education, immediately collapsing the types of people who would be interested in attending, especially at the extremes of high and low earners, is a major problem. Those who attend should be predicated on ability, not be steered by administrators on subtle guesses about income projections 20 years down the road.

Access and Mobility

Related, you don’t want to create a situation where either the university or the state has a fiduciary-like responsibility in finding high-income students to fill its ranks. You don’t want a system like Pay-It-Forward to incentivize the state and the school in picking people it expects to only have high incomes. You don’t want institutions to introduce (more) bias in picking white, male able-bodied students over women, minorities or those with disabilities because of the discriminations that favor the former when it comes to market income. Nor should we want that they emphasize finance over education, the NSA over UNICEF, and so on, based on the reasoning that the health of the university is directly attributable to cash income of graduates 20 years out.

Universities, of course, do this all the time in subtle and not-so-subtle ways. From soliciting donations to legacy admissions to manipulating aid packages, the current system tries to guide their admissions to have high incomes and to extract certain levels of this income. With a bad design, Pay-It-Forward could put that system on steroids.

Another feature of public higher education system is the inter-institutional mobility it provides. Students at community colleges can move up to state colleges, who can also move up to flagship universities. An elaborate, state-by-state system of cross-subsidization allows for this. How would it work for Pay-It-Forward? If a graduate spends one year at community college, two at a state college, and one at a flagship, how should their equity be split among the schools? Even if it is in proportion to years, mobility then introduces an adverse selection, underfunding community and state colleges. How should in-state versus out-of-state applications be addressed? If not properly balanced, Pay-It-Forward could break features of the university that we take for granted, but have been delicately balanced and cultivated over decades.

More broadly, this would also collapse the idea that the purpose of the university is about learning, and instead formulate it specifically as an economic value-add entity that the universities must profit-maximize to survive. This isn’t a vague, hand-waving concern; as mentioned, it could be seen in the admissions process.

Cost Control and Containment

But let’s remember why we are here: costs. In the public space, costs are escalating due to defunding at the local and state college levels and administrative bloat at the flagship level. Will this system bring costs under control and prevent skyrocketing student debt loads? First of all: no. As Sara Goldrick-Rab notes, it also won’t cover the entire cost of schools, still leaving student loans in place to handle room and board.

But what are the advantages of funding public out of general revenues? One is actually hitting the target of affording costs. It will certainly take a few generations to get the actual equity price correct, and even then it will be subject to fluctuations that won’t be easy to correct. This goes double once adverse selection issues come into play. There will be a dramatic amount of uncertainty in trying to project these costs, wherein state tax revenue is far more predictable and can be balanced across other public goals (like, say, taxing gasoline).

Ironically, something like Oregon’s proposal could lead to quicker defunding. If it turns out that it is below what is needed, that’s a problem, that will require hiking the rate. But if it turns out that it raises more revenue than expected, it will almost certainly be matched by a one-for-one decrease in public support, and even an increase in expenses to find ways to spend this windfall. As such, rather than a means of sharing the expenses, it could function as a means to drive public disinvestment much more quickly.

So this form of structuring tuition, without actual cost controls put into place, could make the problem of exploding costs worse. And this program could cause more revenues to drive more costs, all as a result of the way aid is structured. As another dose of amusing irony, this neoliberal solution would make economic, neoliberal critiques of escalating university costs – that universities always spend whatever they get and that aid drives costs, usually referred to as a Bowen and a Bennett effect – actually become true.

Meanwhile using the government to directly drive tuition low in the public sector could not only ensure access but also contain costs in the private sector by acting as a public option. If higher education facilities have some pricing power and demand in inelastic – say because education is the main source of socio-economic mobility in this country–increasing the ability of consumers to spend will lead to tuition increases because part of that spending will be caught by the incumbent institution. Driving the cost down through a public option will, instead, drive down those incumbent incomes.

It’s odd to hear Bruenig talk about “college-obsessed leftism” and the “usual left position,” as if having a well-functioning public higher education system or expressing concern about student debt is an unusually ideological position. Providing accessible, higher education as a public matter is a project going back to the 1800s, it commands strong public support and it’s been one of the reasons our country has thrived with both mass mobility and innovative genius. There is promise in plans like Oregon’s in solving our current crisis in higher education funding, but we must be both aware and careful of the ways in which such a plan could destroy the system of higher education that we’ve built up over centuries.

Read Bruenig’s response in Part III.

Via The GC Advocate

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