Thursday, July 18

Colleges’ Stealth Tax on Family Savings

Its just recently that the UK (specifically England) has started charging for college education. Now its up to £9k per year (ouch!). But here’s an interesting perspective and connection to the savings rate in the USA. I quote:

Consider two young people who have identical potential for success in college based on high-school grades, test scores and so on. Let’s say both are accepted at an upscale private school costing $50,000 a year, or $200,000 for four years. Both kids come from moderately prosperous families with $125,000 in annual income. Student A comes from a family that saved a lot for college by scrimping, buying a modest $200,000 house and paying it off. This family has managed to accumulate $100,000 to defray much of their child’s college costs.

Student B comes from a big-spending family that has a $350,000 house with a big mortgage, and a vacation condo and nice cars, all bought with borrowed money. This family has no college-savings account as a consequence.

Colleges exploit this situation with the assistance of the federal government’s Free Application for Federal Student Aid form, which requires the student to give detailed family financial and other personal information -- income, debts, alimony payments, number of other dependent children and their age, and so on. The college uses this information to determine what the student will pay (up to the $50,000 sticker price).

Tuition Discounts

My guess, based on considerable anecdotal evidence, is that the student from the free-spending family will get a tuition discount of perhaps $25,000, while Student A will get only $10,000. Because that will probably apply for four years, Student A will end up paying $60,000 more than Student B -- solely because of the $100,000 in accumulated savings. The college is imposing the equivalent of a 60 percent tax on the income saved for college.

Moreover, to save $100,000 for college, Student A’s parents would probably have to earn about $150,000 because of taxes. So out of $150,000 in earnings, their child gets only $40,000 closer to paying for college than Student B.

Between real taxes and the private tax imposed by the college’s anti-savings policies, the financially prudent family has to pay more than 73 percent of earnings, a crushing burden that the free-spending family avoids by consuming, rather than saving their money.

But that isn’t all. Student B is forced to borrow more via the college-loan program, which the federal government subsidizes. The implicit value of that loan subsidy is greater to Student B than to Student A -- the federal government implicitly discriminates against those who are frugal and fiscally responsible. This doesn’t even include other anti-saving provisions in federal tax law, such as the impact of double taxation of income at the corporate and individual level.

I was kicking this around and it sort of making sense. This is an interesting situation. I am still struggling with whether or not I should fund my child’s education or let him fund it himself with his savings and debt. Leave aside the issue of means testing (which currently doesn't apply to fees but does apply to maintenance grants).  At this moment, the repayment rate is about inflation plus 3%. Say 5%. frankly, from a pure financial perspective, its better for him to go into debt and then use the investments to get a return which will generally be higher than this rate. There you go, arbitrage zindabad.

1 comment:

bix1951 said...

I have been through this and I agree, the prudent family is penalized and the high living spendthrifts get the benefits, but this is the way most government benefits operate, taking from the the careful and giving to the reckless.