Felix Salmon

How to pay for the seemingly inexorable rise in the cost of college tuition? One idea seems to be having something of a heyday right now: since college graduates earn more money, why not levy a tax on them which will pay for the cost of their education? After all, that’s what Australia has done for years, with reasonable success.

The Australian system is a loan: you essentially borrow the cost of tuition, and then repay it, with interest, through your income tax payments. Once you’ve repaid the loan, no more tax is due. The alternative is some kind of straight graduate tax, as proposed in the UK, Oregon, and, now, by Neel Kashkari in California. Although Kashkari’s proposal doesn’t go into any detail, he does say that he wants to offer “four-year college students majoring in a STEM field free tuition in exchange for a small interest in their future earnings”.

Kashkari is restricting his proposal to STEM students (those in science, technology, engineering, and mathematics), he says, “to address the potential adverse selection problem”: he doesn’t want a bunch of lazy arts students taking advantage of free tuition and paying back almost nothing from their negligible future salaries. Still, Kashkari’s proposal would be voluntary, so any engineer likely to have substantial earnings after college would rationally avoid the scheme. Instead, it would make much more sense for, say, a botanist planning on spending her career in the field, getting by on grants, post-doc stipends, and the like. Adverse selection works within disciplines just as much as it works across them.

In principle, I’m OK with the idea of graduates paying a slightly higher tax rate than non-graduates. Graduates are in many different ways the “better half” of society: richer, healthier, and generally the people who have got the most out of society, rather than those who have been failed by it. As such, it’s reasonable to ask them to share some of their good fortune with society more generally. But if we are going to have a graduate tax, it should be universal, and it should — like all taxes — be compulsory. The very idea of a voluntary tax is a bit silly, and, as Kashkari says, opens itself up to all manner of adverse-selection problems.

A graduate tax would not be a particularly effective way to tackle problems with education costs. If anything, it would only enable those costs to rise even higher. In general, the cost of college rises to the point at which the pips squeak: universities are becoming increasingly adept at charging just about everybody the absolute maximum they can pay. (This explains why rack-rate tuition charges are going stratospheric: the rich can and will pay through the nose for their education, while everybody else gets a “discount” which is carefully calibrated to bring the cost of tuition down barely into the realm of affordability.) If colleges suddenly found themselves with access to a new stream of income from a graduate tax, they would surely just start raising their tuition rates so that students would still have to take out loans to go to college — even after the government had paid the college from the new funds. Even if tuition were paid for in full, students would still need to find a way to pay for textbooks, room and board, transportation, and other costs. Already, tuition and fees amount to only about 40% of the costs of attending a state college; that percentage could easily fall further.

On top of that, a graduate surtax — even if it was limited to a certain number of years after graduation — would almost certainly end up costing most students more money, over the long term, than current tuition does.

A voluntary tax, however, would take all of these problems and severely exacerbate them — it would enable colleges to charge poor people much more than they currently can, and it would force a massive cost onto anybody unable to pay tuition up-front. Essentially, it would be a highly regressive tax — one paid only by the poor and never by the rich. (Think about it this way: if you could reduce your lifetime tax rate by two or three percentage points, at age 18, for an up-front cost of $50,000, or even $100,000, would you do so? You might well, if you were rich. That’s essentially the deal being offered here, only instead of paying to reduce your tax rate, you’re paying to avoid raising it.)

One version of the voluntary tax is a bit more interesting — the fully private version. The most advanced version of this deal is offered by Upstart: once you have a decent degree, you can then monetize it immediately, by pledging some percentage of your future income in return for an up-front payment. I’ve been skeptical of the Upfront model in the past, but I like it more now, partly because the term has come down from 10 years to 5 years. If this is a private tax, it’s one which doesn’t last much longer than college itself. What’s more, Upstart now offers all students a choice: you can either go down the income-share route, or else you can take out a more traditional loan, with a fixed interest rate.

In both cases, the underwriting process is the same, and operates on an individual, case-by-case basis, rather than broadly, in the manner of a government-levied tax.

There are problems with private taxes, of course. For one thing, unlike public taxes, they’re not tax-deductible: you still have to pay state and federal income tax on your gross income, even though some percentage of that gross income is going to flow straight out to Upstart. And that’s not the end of your tax liability. Upstart sells itself as offering downside protection: if you end up earning very little, you don’t need to pay back the full amount you were given up front. But you are very likely to need to pay income tax on it: the Upstart agreement positively shouts that “ANY SHORTFALL BETWEEN THE FUNDING AMOUNT YOU RECEIVED AND YOUR TOTAL PAYMENTS WILL BE REPORTED BY US AS INCOME TO YOU”. In other words, if you don’t pay back more than you were funded for, you’re going to end up paying income tax on money you were given at least five years ago. Which could be unpleasant.

You’re also likely to pay a substantial sum for that downside protection. Upstart reckons that investors in its platform are going to realize pretty healthy annualized returns, across a diversified base of students — significantly higher than typical interest rates on student loans. Which means that the typical student taking advantage of Upstart’s offer will end up paying more than they would if they’d just stuck to traditional loans: in order to think that you’re getting a bargain, you have to believe that you’re going to be below-average in terms of future salary. Still, there can be good reasons to take the offer all the same. For instance, if you spend a couple of years on some labor of love which pays little or nothing, Upstart will simply defer your obligation, while a student-loan lender will not be nearly as forgiving. (The deferment helps the investor too, of course, who would rather wait for you to start earning real money, and thereby get a higher net return on her investment.)

The fact is, however, that paying for college, either before or after you graduate, by paying a fixed percentage of your future income — well, it’s always going to be a niche thing. As far as the mainstream questions about paying for college are concerned, the CFPB has an excellent guide to the traditional choices. Which should exhaust the possibilities for 99% of students.

The fact that Upstart has launched a loan product is telling: it’s a lot easier to sell debt, rather than equity, to institutional investors, who look at Upstart more for its underwriting technology than as a way of trying to disrupt the way we pay for education. (Upstart reckons that it has a comparative advantage in the loans-to-graduates space: it has a pretty good idea of how much they’re likely to be earning, while most lenders, looking at a blank credit report, will refuse to lend at any rate.)

That’s why Marco Rubio’s proposed bill is very likely to go nowhere. It’s a very aggressive piece of legislation: it allows these contracts to run up to a full 30 years, for instance; it pre-empts the rights of any state to regulate such contracts; and it makes all payments under such contracts “not includable” as a part of your gross income for tax purposes. Basically, Rubio seems to want to be able to privatize the ability to tax individuals for decades at a time, and turn what is currently a clear prerogative of the state into a simple contractual matter between citizens and corporations.

Even putting Rubio’s craziness to one side, however, the idea of a surtax on graduates — even if it’s implemented by the state — is hard to implement, and raises various other problems to boot. For instance: what happens with college dropouts? Do they have to pay the surtax for the years they went to college, even if they’re statistically worse off than high-school graduates? In general, do we really want to tax the one thing that pretty much everybody agrees we need more of?

More broadly still, there are always ethical problems associated with the idea of buying and selling human beings — or even small percentage shares of them. (That’s one reason, I’m sure, why Upstart will let you buy a small share of a graduate, but won’t let you sell that share to anybody else.) The dreadful Fantex shares are up and running now, but I still hope and expect that Fantex will fail. Upstart I think has a brighter future — but probably more in loans than in income-share agreements. And as for state-levied graduate taxes, be they in Oregon, California, or anywhere else, I think we’re still a very long way from them actually being implemented. Especially given the broad opposition they’ve already managed to elicit.

Many thanks to Ben Walsh and the Thomson Reuters data team for helping put this chart together. There’s a lot of data here, which isn’t easy to obtain: some 15,000 datapoints in all, going back as far as 1983.

The chart was inspired by this post by Nick Wingfield — the point at which Apple’s market capitalization, in nominal terms, finally exceeded the previous all-time high, which was set by Microsoft in 1999. So we went back and took the closing share price of AAPL and MSFT for every day since they went public, and plotted the market cap against the p/e ratio every day. Apple’s closing prices are in blue; Microsoft’s are in red.

The first thing to notice is the huge difference in p/e ratios at the maximum market cap. The highest AAPL point is a market cap of $627 billion, with a p/e ratio of 15.7. The highest MSFT point, by contrast, is a market cap of $615 billion, with a p/e ratio of 73.

Apple too has traded at whopping great multiples in the past — just look at that long tail of blue dots hugging the x-axis. (In fact, for the sake of clarity I truncated that axis a bit, since it goes on a lot further out than that.) But if you bought AAPL stock at a p/e of 373 you’d look pretty smart right now: the shares have gone up almost 100 times since then. Whereas, if you bought MSFT stock at a p/e of 73, you would just have ended up losing a lot of money.

If you stop looking at individual points and start looking just at the general shapes of the charts, there’s a strong positive correlation on the Microsoft datapoints, and a strong negative correlation on the Apple ones. Generally, with Microsoft, the higher the market cap the higher the p/e; whereas with Apple, the higher the market cap the lower the p/e. (Mathematically, the correlation on the Microsoft data +0.22, while the the correlation on the Apple data is -0.10.)

What this says to me is that the market in Apple shares looks a lot more rational than the market in Microsoft shares. Investors will pay huge multiples for Apple shares when the company looks cheap, but not when the company looks expensive. When Apple breaks the half-trillion barrier, that’s despite the fact that its p/e ratio is low; when Microsoft breaks that barrier, it’s because its p/e ratio is high.

So when Wingfield talks about “investor euphoria” surrounding Apple, bear in mind that the euphoria he’s talking about is very different from the kind of euphoria we saw at the height of the dot-com bubble. Apple is indeed worth a truly enormous amount of money. But investors don’t see the kind of scalability in Apple, circa 2012, that they saw in Microsoft circa 1999. Despite the fact that the global market for smartphones today is vastly greater, and growing much faster, than the global market for Windows software was in 1999.

Update: I’ve put the data here for those who want to play around with it themselves.

Scott Asen, a former trustee and head of the development committee at Groton, a posh private school, has a revealing op-ed in the NYT. He explains that at such schools, the tuition fees, high as they are, fall well short of covering the annual costs that the schools incur; the difference is made up by donations and, where it exists, by using the school’s endowment. What’s more, that fact is explicitly communicated to parents. “Virtually every private-school parent has heard about ‘the gap'”, he says, and, as a parent, once you know about it, it’s clear what you should do:

To the extent that any family with the wherewithal is paying less than the full cost of the product it is buying through combined tuition payments and donations, that family is effectively being subsidized by other current and past donors. Not only is this ethically unsupportable, but ultimately, it is also financially unworkable.

Asen proposes that all parents who can afford to do so, or who fail to provide financial disclosures proving that they can’t afford to do so, should be “expected” to “fill the gap” with a donation. “Given the strength of the educational product offered by these prestigious schools,” he writes, “I think that for every affluent family scared off by the new policy, there would be another of equivalent means — with an equally desirable child in tow — willing to pay full cost.”

Many parents are following these guidelines already, thanks to pressure from people like Asen. “It’s sort of understood that if your children attend these schools and you can afford it, you will pay all or some of that shortfall,” one father told Jenny Anderson.

The operative word here is “pay”. These payments are just that: money spent to cover the costs of educating Junior. As Asen’s headline puts it, right now private schools are “not expensive enough” — they should cost more. And while the extra money might be couched as a donation for tax purposes, both the school and the parents understand that if you’re merely “filling the gap”, rather than, say, donating a couple of million dollars towards a new gym, then you’re really just covering the annual cost of your kid’s tuition.

Such expenses are not, and should not be, tax-deductible. What Asen is proposing comes very close to tax fraud: he’s clearly saying that if you’re the kid of parents of means, and your parents refuse to fill the gap, then you would no longer be welcome at school. For rich parents, this is to all intents and purposes a tuition hike. But it’s sweetened, a little bit, with the fact that the hike is fully tax-deductible.

Tuition hikes at private schools have never been tax-deductible in the past, and they shouldn’t be tax-deductible now. If Asen wants to suggest that private schools should just raise their rack rate to an amount that covers the cost of tuition, and then use some of the extra revenue to help defray the cost for children of parents outside the 1%, then that I think would be perfectly reasonable.

There’s a curious tension among the kinds of people who send their kids to private school: on the one hand, they do so in large part precisely because these are the schools attended by the kids of the money-is-no-object types. But on the other hand, they like to think that the schools are attended by a diverse group of the best and the brightest, rather than just the richest. And so they support the idea that some carefully hand-picked kids from less flush families should also be able to attend. If Asen’s proposal was a simple tuition hike with some kind of concomitant increase in financial aid, then, it would just represent an institutionalization, within the tuition structure, of diversity principles which are already espoused by most private schools.

But Asen doesn’t go that far. Instead, he takes to its logical conclusion the woeful trend of the transactionalization of philanthropy: the idea that it is entirely normal and expected for every tax-deductible philanthropic donation to be tied to the charity in question providing something of value in return. It starts with the tote bags given out during public-radio pledge drives, and ends with the very institution changing its own name to yours: the Peter G Peterson Institute for International Economics, the Booth School of Business.

In general, where something of real value is given back, only the difference is tax-deductible. If I buy $350 tickets to a charity dinner, and the dinner costs $150, then only $200 can be written off against taxes. And if I get a discounted ticket to the dinner, paying only $100, then none of my payment is tax-deductible. That’s essentially the situation that private-school parents are in right now: they’re buying discounted tickets to an extremely expensive education. If they end up forking over a bit more, but still less than the education costs, then nothing changes, and the extra amount they pay should still come out of post-tax income.

All of which helps to explain why private schools charge less for tuition then they spend on providing it. Within days of their kid being accepted at a private school, parents are informed about the famous gap, and pressured to fill that gap with a donation. In the school’s ideal world, all parents would then fill that gap to the limit of their ability to pay — and rich parents would give even more. The parents, of course, will always be happier paying low tuition and topping it up with a tax-deductible donation than they would be simply paying higher tuition.

But donations have to be voluntary, and no matter how good a school is, there are always worthier charities out there. After all, the US already has universal education: the charitable purpose of the private school is just a marginal increase in the quality of some children’s education — complete with deleterious effects on everybody else. (Just imagine how much better Manhattan’s public schools would be, if all of the island’s super-rich had to send their kids to those public schools.) If I have $10,000 to give to charity, it’s really hard to believe that the first best recipient of that money would be some private school, rather than, say, Doctors Without Borders.

So if schools want parents to donate money, they have to offer something extra in return: they have to offer to educate the parents’ kids. That’s why tuition is set below the cost of education: it forces the parents, in aggregate, to donate the difference, for fear that otherwise the kids’ education might suffer. And it also helps to lay the groundwork for deals like the notorious one between Sandy Weill and the 92nd Street Y: Sandy donated $1 million of Citigroup’s money to the school, and his star analyst managed to get his twin daughters into the pre-school there.

That deal was particularly obnoxious, but it’s entirely commonplace for very rich parents to drop very large hints, along with their private-school applications, that if their kids get in, substantial donations will accompany them. Naturally, the schools are predisposed to accept precisely those kids. Given that those donations appear if and only if the kids attend the school in question, there’s a case to be made that all such donations, even if they’re much larger than the gap, are in effect payment for tuition, and should not be tax-deductible.

I’m no fan of the tax-deductibility of charitable donations in the first place — it’s an enormous tax expenditure which results in a relatively modest amount of extra charitable giving. (Ed Dolan has a good two–part overview of why the deduction is a bad idea.) But let’s put that debate to one side for the time being, and make the reasonable assumption that the deduction is here to stay. Let’s also make the equally reasonable assumption that Asen’s proposal won’t get adopted by any private schools, for the very good reason that it would never pass muster with the IRS.

Then what we’re left with is an admirably clever op-ed by Asen, which sends one message while purporting to say something else entirely. His op-ed is nominally directed at schools, saying that they should change their tuition structure. But the real target is not schools but parents. He’s telling them that private-school cost inflation is enormous, and that they have an ethical obligation to fill the gap, every year, if they can possibly afford to do so. Stripped down, the message is this: “give more, or you won’t like the consequences”.

Development officers sharing Asen’s op-ed with parents will surely be very quick to point out that you can’t make tuition a tax-deductible expense, and that if schools were going to raise their tuition rates, none of that raise would be tax-deductible. As a result, they’ll say, it’s much better for all concerned if the present situation stays in place, and parents top up their tuition fees with tax-deductible donations.

Asen’s op-ed, then, is at heart a fundraising drive aimed at the status quo, rather than a real attempt to change that status quo. As you would expect from someone who spent many years raising funds for a private school. I wonder if the NYT realized that, when they printed it.

I have absolutely no idea what on earth might be going on with the MANU stock price. But it’s definitely another datapoint supporting the thesis that IPOs are weird things best avoided. (See also Facebook, of course, and Groupon, and just about any of the other buzzy companies to have gone public of late.)

The chart above — there’s a bigger version here — shows the Man U’s share price since the IPO last week. And the weirdest bit of all is actually the first day, when seemingly nothing happened: the stock never moved more than 2% from its IPO price.

But as Matt Levine noted that afternoon, after the market closed, the underwriters were clearly supporting the stock at the IPO price of $14, and the volumes being transacted at that level were truly enormous: much bigger than the official greenshoe. Either someone was accumulating an absolutely massive chunk of stock in the open market, or else the underwriters sold an insane quantity of shares at the IPO — almost double the final free float of 16.67 million shares. Neither theory was particularly plausible on its face.

Clearly without support, the Man U share price would have dropped below $14. But then something very weird happened when the shares reopened on Monday August 13: after half an hour at $14 per share, they suddenly spiked; at one point that morning they were more than $15 per share. Was Man U stock going up, rather than down? Were the people who bought on the opening day being vindicated? Or was this some weird kind of short squeeze?

Subsequent price action didn’t help clear anything up. On Day 3, Tuesday, someone was clearly providing support at $14.16 per share. And on Day 4, Wednesday, we had a mini-repeat of what happened on Monday: the stock suddenly spiked upwards for no good reason from its former support level.

By the end of the day, however, and on Thursday afternoon, we were back down to the $14 IPO price — and again someone was supporting at that level — until, at 11:10am, they weren’t. At long last, the drop that everybody had expected for Monday morning had finally arrived, and for the time being the stock is floating around somewhere near the $13.40 level.

I could try to construct a narrative which might explain all this, but I’d frankly just be making things up. The one thing that I can be pretty sure of is that we’re not seeing price discovery here: this isn’t the natural forces of supply and demand determining how much Man U shares are worth. What it is, however, I have no idea at all.

Update: This might explain a lot.