July 14, 2013

Save for college? You do the math

If you scrimp and save toward your child's diploma, you'll end up shelling out far more than the parents who didn't.

By RICHARD VEDDER/Bloomberg News

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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).

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.

Surprisingly little academic work has been done on this form of taxation, perhaps because college professors indirectly benefit from this policy. While colleges have raised their sticker prices a lot because of the availability of relatively low-cost federally subsidized loans, they have increased actual fees paid by high-saving families through stealth means, exploiting family financial information uniquely given to them and not to other sellers of goods and services.

In the interest of promoting higher savings (with all sorts of positive macroeconomic implications, such as lower interest rates and greater capital formation), why doesn't the federal government abolish the Free Application for Federal Student Aid form and make it a criminal offense to solicit private family financial information? At the minimum, all information on family finances, other than overall income (which could be provided to colleges by the Internal Revenue Service), would be excluded.

In sum, let's abolish the stealth tax on savings.

Richard Vedder, a contributor to Bloomberg View, directs the Center for College Affordability and Productivity, teaches economics at Ohio University and is an adjunct scholar at the American Enterprise Institute.


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