Does It Really Pay to Go to College?

Rob Toutkoushian

Introduction

Economists often refer to going to college as an investment in a person’s skills, or human capital, which are then rewarded in the labor market. If postsecondary education is indeed an investment, then how large is the return on that investment? And how does the return to postsecondary education compare to other investment options? The answers to these questions are particularly important as policymakers, academics, media commentators, and students and their families debate whether society would benefit from having more individuals go to college.

At first glance, it would appear that college is a wise financial decision for students. Those who advocate for higher education often point to the gaps in average salaries by educational attainment as evidence that there is a financial payoff to students from going to college. A typical example of this is illustrated in Table 1, which shows the median earnings for individuals ages 25-64 broken down by highest degree earned. The data show that the average earnings rise substantially with educational attainment. According to data from the U.S. Census Bureau, the median earnings for those who were employed in 2011 and held a Bachelor’s degree or higher ($50,243) was 70% higher than the average earnings for someone whose highest degree was a high school diploma ($29,556). Because unemployment rates tend to decrease as educational attainment increases, the average salary gaps rise when unemployed individuals are included in the calculation. It is therefore not surprising that numerous academic studies using data such as these have found that there are sizable financial gains from investing in education at the primary, secondary, undergraduate, and graduate levels (see, for example, Psacharopoulos, 2008; McMahon, 2009).

	Employed Individuals		All Individuals
Educational Attainment	Median	% Above High School	Median	% Above High School
High School	$29,556		$20,361
Some College	$32,555	9%	$24,790	22%
Associate's Degree	$37,230	26%	$30,662	51%
Bachelor's Degree	$50,243	70%	$41,807	105%
Master's Degree	$61,419	108%	$54,313	167%
Doctor's Degree	$81,496	176%	$75,402	270%
Professional Degree	$90,553	206%	$80,120	293%

Not everyone, however, is convinced that the payoff from going to college is large enough to justify the investment. Nearly 40 years ago, Richard Freeman (1976) made the argument that there were too many college-educated workers, which would lead to a reduction in the financial return on a college degree. In more recent years, media commentators such as Richard Vedder and Robert Samuelson have raised similar concerns in response to the push among policymakers to get more students to go to college and earn degrees. Critics point to the rapid increases in tuition to suggest that the return on a college degree is falling. In addition, they argue that many students are not academically prepared to do college work, and they “…shouldn’t be wasting their own resources and those of their families and taxpayers” (Williams, 2012).

Critics have also noted that one of the limitations with many studies is that they focus on the return for only those students who graduate with a degree. In doing so, these studies likely overstate the average return for all students who go to college because roughly one-third of degree-seeking students who enroll in a 4-year institution do not graduate within six years. Those students who go to college but do not graduate will incur substantial costs and yet receive smaller income gains than their peers who earn college degrees. Vedder (2012) explains the problem as follows:

“The ‘college-for-all’…crow argues, correctly, that the average college graduate earns more than the average high-school one. But that calculation fails to use a more appropriate measure…to analyze the return to college. Specifically, if 45 percent or so of students fail to graduate in six years, earnings comparisons unadjusted for the high risk of dropping out are totally inappropriate.”

The question of whether there is a financial payoff to going to college is important for society as a whole, as well as for individual students and their families. A large portion of postsecondary costs are subsidized by governments, private donors, and so on. It is hoped that society will benefit from these public investments due to the possible spillover benefits (or positive externalities) that are generated when more individuals acquire a postsecondary education. These benefits may be financial,

such as through greater economic growth or lower expenditures for health care and corrections, or non-financial (such as through improved  civic participation). However, evidence is needed to see if this is indeed the case.

Background

By the 1960s, economists had developed the cost-benefit framework that is still in use today to calculate whether the future benefit from investing in education exceeds the cost. An excellent early review and description of the cost-benefit framework can be found in Prest and Turvey (1965). As noted by Prest and Turvey (1965, p.683), the cost-benefit approach “…is a practical way of assessing the desirability of projects, where it is important to take a long view (in the sense of looking at repercussions in the future, as well as the nearer, future) and a wide view (in the sense of allowing for side-effects of many kinds on many persons, industries, regions, etc.).”

Cost-benefit analysis is an appropriate analytical tool to use in settings where the investment in a project or program is substantial, the costs and benefits are realized at various points in time, and the decision to invest involves uncertainty about the costs and benefits (Prest & Turvey, 1965). This description certainly applies to education, where both individuals (students and their families) and the public at large allocate substantial resources to producing and acquiring education, and the benefits are received long after the tuition bills have been paid. By the early 1960s, economists had begun to apply the benefit-cost approach to estimating the return on investing in various levels of education, ranging from primary schooling to graduate education. W. Lee Hansen (1963), for example, found that investments in a 4-year college degree in the 1940s and 1950s yielded internal rates of return to students of between 11 and 15 percent. As documented in the literature reviews on the rates of return to education conducted by Psacharopoulos (1973; 1985; 1994), numerous studies have now been conducted in the United States and around the world, with the preponderance of the evidence showing that there are large financial returns to education at all levels.

How to Measure the Return on Education

There are three ways to measure the “return” to college: (1) the net present value of discounted benefits minus discounted costs, (2) the ratio of discounted benefits to cost, and (3) the internal rate of return on costs that generate benefits. The net present value is popular in policy studies because the results are easy to understand, but the values are difficult to compare to other studies and investments. Although the ratio of benefits to cost is a standardized measure, it cannot be compared to investments such as stocks and bonds. The majority of academic studies measure return based on the internal rate of return because it is a standardized measure that can be related to other investments. The internal rate of return can be thought of as the annual return that would be needed on costs to create a certain level of future benefits. For example, if $10,000 invested today grew to $15,000 by next year, then the internal rate of return on the investment was 50%.

Economists have also distinguished between the return received by individuals (“private return”) and the return for society as a whole (“social return”) due to college. Although the early work on cost-benefit analysis focused exclusively on the social return to investing in a project, studies in education have also examined the private return received only by students and their families. Of course, this makes sense because unlike large public works projects where all investments are made by the government, educational costs are paid for by students and society. Federal, state, and local governments devote resources to help students go to college, in the hope that they will also benefit from the investment.

Another important issue for economists to address is what types of costs and benefits should be part of these calculations. The financial (market) costs and benefits are the most obvious choice for inclusion in the private and social return to education calculations because they are what we usually think of when it comes to investments. The costs would include direct costs paid by students, as well as indirect costs due to the income that students give up when they go to college. Market costs and benefits have the added advantage of being relatively easy for the researcher to measure. However, there are a number of other potential costs and benefits associated with going to college that are not easy to measure. For example, the financial benefits that a nation experiences when more education leads to a higher standard of living, or reduced medical and correctional expenditures, are difficult to estimate. There are also a wide range of non-market benefits from education, such as from improved civic behavior of citizens, that are even more difficult to measure and translate into financial benefits and costs. A comprehensive examination of these issues can be found in Walter McMahon’s book Higher Learning, Greater Good (2009).

Prior Findings

There have been numerous studies conducted across the globe to measure the average financial return from investing in higher education. George Psacharopoulos in particular is known for his summaries of findings from studies across time, nations, and levels of education. Researchers have given most attention to the financial return from completion of a Bachelor’s degree. However, a number of researchers have also measured the return to earning an Associate’s degree or a graduate degree.

There have been a few policy reports sponsored by entities such as the College Board that have estimated the average financial benefit to students from earning a Bachelor’s degree. Day and Newburger (2002) estimated that as of 1999 the lifetime financial benefit from a Bachelor’s degree was $1.1 million for males and $600,000 for females. Similarly, a report by Carnevale, Rose & Cheah (2011) concluded that the lifetime financial benefit in 2009 from having a Bachelor’s degree was approximately $1 million. Perhaps the best of the more recent policy reports on this topic was conducted by Baum, Ma, & Payea (2010). The authors found that Bachelor’s degree recipients in 2008 would on average expect to earn about 66% more than high school diploma holders over their lifetimes. This equates to a discounted benefit gain of approximately $530,000. However, these policy studies do not take costs into account in their calculations, and they focus solely on the benefits for graduates.

In contrast, the vast majority of academic studies on the return to postsecondary education present their findings in terms of the internal rate of return on investment. Overall, these studies have found that there are double-digit private and social rates of return to graduating from college with a Bachelor’s degree. However, the social rates of return estimates tend to be smaller than the private rates of return because it is hard to measure social benefits and studies often overestimate social costs. Although the internal rates of return to Bachelor degree completion varied considerably across nations, the estimates tended to fall between 10-20 percent per year, which compares favorably with other investments. McMahon (2009) provides similar evidence on the private and social rates of return to higher education in OECD countries. In most cases, however, these studies also focus on the return for students who graduate from college.

To summarize, although the vast majority of studies point to large financial benefits from college, there are questions that persist with regard to these studies. How large is the return to college when we take into account those students who do not graduate with a degree? Does the return vary by type of institution? Is the return large even for those students who pay higher tuition rates and/or receive less financial aid? And what can we learn from the different measures of “return” to college?

New Findings

I have explored these questions through some of my recent research on the return to college. In a forthcoming study in The Journal of Education Finance, my co-authors and I show how to estimate the average financial return to going to college for all those who attend college, and not only those who graduate. This is important because students do not know with certainty whether or not they will graduate at the time that they decide whether to go to college. We provide separate calculations for public and private institutions, we take into account the different unemployment rates for individuals by degree level, and we simulate how the return will vary for students paying relatively high net prices for college. I have also been expanding this analysis to 2-year institutions in a book that I am writing on the economics of postsecondary education.

To obtain these new estimates, let’s assume that a student begins college at age 18 and attends college for up to six years, after which he or she works until age 65. To account for the risk of non-graduation and the timing of graduation, we used data on the average dropout and graduation rates by year for public and private institutions. The costs of going to college were set equal to the average net prices faced by students in each sector, and public support was defined as government support for instructional activities. We used average total earnings by degree level for all workers ages 25-34 as the starting place for the market benefits. The student was assumed to work part-time during college, earning 10% of what he/she could earn if not attending college.

A summary of the key findings for students seeking a Bachelor’s degree are presented in Table 2. For public and private institutions, we report measures of the return for graduates, nongraduates, and all students combined. We calculated each of the three measures of return to higher education (net present value, ratio of benefits to costs, internal rate of return) for each group, assuming discount rates of either 0% or 3% per year. It should be noted, however, that due to data limitations we restricted the average incomes for graduates of public and private institutions to be the same.

Table 2: Estimates of Return to Pursuing a Bachelor's Degree in the United States, 2011.

Measure of Return to Higher Education	Public Institutions			Private Institutions
	Graduates	Non-Gradiates	All Students	Graduates	Non-Graduates	All Students
Private Return
NPV (0%)	$1,246,937	$42,719	$842,040	$1,210,044	$34,868	$930,916
NPV (3%)	$523,571	$12,155	$352,651	$488,013	$4,198	$376,657
Ratio (0%)	18.85	3.64	12.33	12.33	2.45	12.69
Ratio (3%)	8.88	1.74	5.79	5.79	1.17	5.91
IROR (0%)	18.1%	5.7%	17.1%	13.7%	3.7%	13.7%
Social Return
NPV (0%)	$1,621,370	$43,599	$1,096,526	$1,619,526	$48,081	1,245,146
NPV (3%)	$658,898	$2,963	$444,886	$656,040	$7,180	$505.995
Ratio (0%)	13.07	2.25	12.88	12.84	2.58	13.17
Ratio (3%)	6.16	1.08	6.01	6.02	1.23	6.14
IROR (0%)	14.4%	13.9%	13.9%	14/1%	4.0%	14.1%

We found that the financial returns for Bachelor’s degree recipients are substantial. The net present values of benefits are in the general range of $500,000 to $1.2 million for public and private institutions, depending on the discount rate that is assumed for time preference. Similarly, the ratios of discounted benefits to costs ranged from 8.88 to 18.85 for public institutions and 5.79 to 12.33 for private institutions. The private internal rates of return for graduates were also large (18.1% for public institutions and 13.7% for private institutions), and comparable in magnitude to findings from other studies.

At the other extreme, those who attend college but do not earn a Bachelor’s degree experience substantially lower returns from their investment. The private net present values only range between $4,000 to $43,000 across both types of institutions, with benefits exceeding costs by ratios of between 1.74 to 3.64 (public) and 1.17 to 2.45 (private). The resulting internal rates of return (5.7% for public institutions and 3.7% for private institutions), while positive, were lower than the common standard of 10% used for comparison in these studies. Clearly, college is not a good investment on average for those who do not graduate.

When we put both graduates and non-graduates together, we found that the net present values for public and private institutions were still substantial but about one-third below the values for only those who graduate from college. Because both the costs and benefits for all students were lower than the costs and benefits for graduates, however, the resulting ratios of benefits to costs and internal rates of return were similar for both groups (17.1% for public institutions and 13.7% for private institutions). Taken together, although the average rate of return for all who attend college is similar to the rate of return for graduates, there is a notable difference in the average financial benefits as reflected in the net present value of the investment.

Turning to the social returns to postsecondary education, we observed that the net present values of social returns were higher than the private net present values. This indicates that the additional public benefits (from taxes) exceed the higher costs due to governmental support for higher education. However, the ratios of social benefits to costs for all students combined were smaller than the ratios of private benefits to costs. Finally, the social internal rate of return for public institutions was still sizable (13.7%), but smaller than the private internal rate of return. In contrast, the social and private internal rates of return for private institutions were very similar to each other (14.1% and 13.7%, respectively). We repeated these calculations for students assuming that they did not receive any grants or scholarships, and had to pay relatively high tuition rates. Even in these instances, the average financial benefits outweighed the costs by amounts large enough to justify the expenditure.

In Table 3, I present similar estimates of the return to attending a public 2-year institution. It can be seen that the internal rates of return for graduates of 2-year institutions are somewhat higher than for 4-year institutions, which has led some to suggest that going to a 2-year college is a better investment than going to a 4-year college. However, due to the lower completion rates at 2-year institutions, the average return for all attendees is higher at 4-year institutions. More importantly, the dollar return, as measured by the net present value, is nearly twice as high for those students who attend 4-year institutions. If students care about the dollar benefit from college more than the percentage return on investment, then this would argue in favor of attending a 4-year institution.

Table 3: Estimates of Return to Pursuing an Associate’s Degree at Public Institutions in the United States, 2011

Measure of Return to Higher Education	Public Institutions
	Graduates	Non-Graduates	All Students
Private Returns
NPV (0%)	$648,376	$45,320	$252,811
NPV (3%)	$275,201	$14,796	$104,415
Ratio (0%)	21.86	3.57	12.37
Ratio (3%)	10.06	1.85	5.7
IROR (0%)	21.1%	6.7%	14.7%
Social Returns
NPV (0%)	$842,114	$47,215	$321,178
NPV (3%)	$345,057	$6,650	$123,555
Ratio (0%)	14.19	2.29	8.05
Ratio (3%)	6.53	1.18	3.76
IROR (0%)	13.6%	3.9 %	10.08 %

Conclusion

So is college still a good financial investment for students and society? The data shows that the average benefits from college outweigh the costs by an amount great enough to make it worthwhile. Although factoring in the risk of not graduating lowers the dollar benefits, the remaining difference is still very large. At the same time, the average return for students who do not earn a degree is fairly small. This has implications for policies that are designed to entice more students to go to college. For those with a reasonable chance at success, the investment would seem to be a good decision. However, for those students with a very low probability of graduating, it is questionable whether going to college is a worthwhile use of time and resources. This is particularly true as politicians including President Obama and organizations such as the Lumina Foundation are calling for more students to attend college. In his 2012 State of the Union address, for example, President Obama described higher education as an “…economic imperative that every family in America should be able to afford.” (Williams, 2012). Likewise, the American Council on Education (ACE) argues that “higher education is essential and has an extraordinary payoff.” (Fain, 2012). The findings presented here suggest that while the average payoff is in fact substantial, one cannot conclude that the same payoff would apply to those students who are not prepared to do well in college.

References

Baum, S., Ma, J., & Payea, K. (2010). Education pays 2010. New York: The College Board.

Becker, G. (1962). Investment in human capital: A theoretical analysis. The Journal of Political Economy, 70, 9-49.

Carnevale, A., Rose, S., & Cheah, B. (2011, August). The College Payoff: Education, Occupation, and Lifetime Earnings. Washington, DC: Georgetown University, Center on Education and the Workforce.

Cohn, E., & Geske, T. (1990). The Economics of Education (3rd edition). Oxford, UK: Pergamon Press.

Day, J., & Newburger, E. (2002). The big payoff: Educational attainment and synthetic estimates of work-life earnings. Washington, DC: U.S. Census Bureau.

Fain, P. (June 29, 2012). College for all? Politicians and pundits ramp up questions about value of degrees. Inside Higher Education. Retrieved June 29, 2012 from http://www.insidehighered.com/news/2012/06/29/politicians-and-pundits-ramp-questions-about-value-degrees

Freeman, R. (1976). The Overeducated American. New York: Academic Press.

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McMahon, W. (2009). Higher learning, greater good: The private and social benefits of higher education. Baltimore, MD: The Johns Hopkins University Press.

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Samuelson, R. (May 27, 2012). It’s time to drop the college-for-all crusade. Washington Post. Retrieved on June 29, 2012 from http://www.washingtonpost.com/opinions/its-time-to-drop-the-college-for-all-crusade/2012/05/27/gJQAzcUGvU_print.html

Toutkoushian, R., Shafiq, M., & Trivette, M. (2013). Accounting for risk of non-completion in private and social rates of return to higher education. Forthcoming, Journal of Education Finance.

Vedder, R. (June 6, 2012). Ditch the college-for-all crusade. The Chronicle of Higher Education. Retrieved June 29, 2012 from http://chronicle.com/blogs/innovations/ditch-the-college-for-all-crusade/32661.

Williams, W. (June 26, 2012). How many college-educated janitors do we need? Charlotte Observer. Retrieved June 29, 2012 from http://www.charlotteobserver.com/2012/06/26/3341588/how-many-college-educated-janitors.html.

About the Author

Robert Toutkoushian came to the University of Georgia from the Department of Educational Leadership and Policy Studies at Indiana University. Dr. Toutkoushian specializes in the application of economic theories and quantitative methods to problems in higher education. He has a Ph.D. in economics from Indiana University, and prior to joining the faculty at Indiana University, he worked as a research analyst at the University of Minnesota, and as executive director of the Office of Policy Analysis at the University System of New Hampshire. Professor Toutkoushian has published nearly thirty studies in peer-reviewed journals on topics including faculty compensation, student demand for higher education, finance, and policy analysis. He is currently involved in an analysis of educator pension plans, a study of the alternatives states can use to financially support higher education, and the writing of a book on the economics and finance of higher education. He is editor of the journal Research in Higher Education and associate editor for the series Higher Education: Handbook of Theory and Research. He is the 2013 recipient of The Sidney Suslow Award given by the AIR.