Listener 29 March 1997.

Keywords: Education

Funding of tertiary education has changed dramatically from the days when virtually any eligible young person could go to university or a polytech mainly at the taxpayers expense. The new policy has been justified by “human capital theory”, which treats expenditure on education as if it is an investment which only enhances the student’s earning power. The commercial logic is people make private investment decisions about their education, deciding whether to go and which course to take, on the basis of the return to their income. There should be no public subsidies to distort their decisions.

Does it matter if the return is low? There is a tricky point here. If the private return to tertiary training is low, then people will not invest in it, but do other things with their time and money. That would, so the approach would argue, be a better allocation of resources.

Many would think that a surprising result, because they see tertiary education having a broader impact, than just the return to the individual from the investment in a vocational training. Insofar as these benefits exist – economists call them `externalities’ – they invalidate the conclusions from the commercialist analysis that if there is no private return on getting university training, then it is not in the nation’s interest to proceed with it.

There are complications to human capital theory. Consider `human cattle theory’. Suppose a bovine student went to university, obtained a degree, and as a result of that degree enhanced subsequent earning powers in terms of higher milk production. The costs of obtaining the degree would be tax deductible. Since in their student years they would make a loss from their training expenses, and from the feeding, watering, and housing of the animal, there would build up a tax credit over the years during which they obtained a qualification. Thus immediately out of university the cow would pay no tax on her earnings, until the tax credit was exhausted. The tax liability of the cow differs from that of human student.

Moreover, farmers are able to raise a higher proportion of the value of the beast as a loan from the private financial system, than human students can on their human capital. Why? Bankers can own cattle, but due to anti-slavery laws they cannot own people. This restriction represents an important distortion in the labour market, which severely limits the usefulness of human capital theory.

There is much to be learned from the human capital model as an intellectual exercise, and it has some relevance to the policy issues. But human cattle theory demonstrates there are serious limitations to the human capital theory. Perhaps the application of human capital theory contains a bit of bull.

In the meantime students suffer, while the rest of us – especially those who had access to a cheaper tertiary education in the past – benefit from lower taxes. In the March 1991 year the government probably got about an extra $4 billion of tax revenue as a result of the higher incomes of those with tertiary education. Suppose half of that was from natural ability, so $2b is the a result of obtaining qualifications and the skills that go with them. However the total government spending on tertiary education was only $1.5 billion. Even assuming that tertiary education generates no externalities or general benefits to the public, the government made a tidy profit of a return of $1.33 for every $1.00 it outlaid.

The public return is better than that, because there are general benefits, and because we should be looking at the return on tertiary spending in the past. Moreover, the fiscal stance since then has been to squeeze tertiary spending, pushing more of its costs onto students. The return to the taxpayer may be over $2 for every $1 spent.

In the past we gave students almost free tertiary education, and recovered the public spending (on average) by the additional tax the graduates paid. Today we charge the students an increasingly large share of their tertiary education bill, and still cover all the costs on the tax payments. In effect we confiscate a share of the human capital of the younger generation, transferring it to their elders in lower taxes, while the young build up a huge debt. We would not do that for private property or even to cattle, would we?

So either we should take the human capital model to its full logic, and allow students to deduct their cost of education from their tax liability just as if they were cattle. Better still, the government should fund the costs of the tertiary system to the level that it gets a fair return in higher taxes. The profits from the investment then go to the students and are not expropriated by the state, as is proper for a liberal democracy, if not an authoritarian state.
If we do not change the current strategy, the younger generation will conclude their elders are mean, selfish, and unprincipled – and rightly so.