February 10, 2018
Private firms often withhold information or contest scientific knowledge when public revelation could lead to costly regulations or liability. This concealment leads to negative externalities and public harm.
But what if private firms’ superior knowledge and self-interest could be harnessed to reveal information about risks and accelerate the implementation of safety regulations?
In Limited Liability and the Known Unknown, I argue that firms that desire limited liability for their investors should be forced to pay what they believe limited liability is worth. This would have several salutary effects. Firms’ choice between unlimited liability and higher taxes would reveal important information about internal risk assessments, reduce public-private information asymmetries, and accelerate the application of scientific knowledge to personal and public health.
Limited liability is a double-edged sword. On the one hand, limited liability may help overcome investors' risk aversion and facilitate capital formation and economic growth. On the other hand, limited liability is widely believed to contribute to excessive risk taking and externalization of losses to the public. The externalization problem can be mitigated imperfectly through existing mechanisms such as regulation, mandatory insurance, and minimum capital requirements. These mechanisms could be more effective if information asymmetries between industry and policymakers could be reduced. Private businesses will typically have better information about industry-specific risks than policymakers.
A charge for limited liability entities-resembling a corporate income tax but calibrated to risk levels-could have two salutary effects. First, a well-calibrated limited liability tax could help compensate the public fisc for risks and reduce externalization. Second, a limited liability tax could force private industry actors to reveal information to policy-makers and regulators, thereby dynamically improving the public response to externalization risk.
Charging firms for limited liability will lead private firms to sort themselves by riskiness and reveal information to policymakers. Policymakers will then be able to focus their attention on the industries that have collectively self-identified as high risk and develop more finely tailored regulatory responses. Because the benefits of making the proper election are fully internalized by individual firms, whereas the costs of future regulation or limited liability tax changes will be borne collectively by industries, firms will be un-likely to strategically mislead policymakers in their elections. By helping to reveal private information and focus regulators' attention, a limited liability tax could accelerate the pace at which policymakers learn and therefore the pace at which regulations improve.
February 07, 2018
House Republicans propose to open floodgates to federal funding of low-quality for-profit, online degrees (Michael Simkovic)
House Republicans recently proposed to increase federal funding for the worst performing parts of higher education and reduce federal funding for the best performing parts.
For-profit ("proprietary") brick-and-mortar and online educational programs tend to have low rates of student completion, relatively poor employment outcomes, and relatively high student loan default rates compared to private non-profit and public institutions. For-profits' typically poor outcomes may be at least in part because for-profit programs typically spend far more on sales and marketing than traditional non-profit programs. This leaves fewer resources available for instruction and support services for students, or research that can help build an institutional reputation and connections with employers. Paying profits out to investors also drains cash and limits how much can be spent on instruction in any given year.* Short-term programs at for-profits are the only category of higher educational institution that have been shown by peer reviewed research to increase their prices without increasing educational quality upon gaining eligibility for federal aid.
Default rates of for-profit programs used to be even worse in relative terms, before rules were implemented to deny eligibility for federal student loans to the worst performing for-profit institutions.
A new House bill sponsored exclusively by Republicans, H.R. 4508,** threatens to open the floodgates to federal funding for for-profit and online education of dubious quality. According to the CBO, the bill would:
"Amend or repeal restrictions on institutional eligibility for federal student aid for certain types of schools, the largest of which would repeal the definition of distance education and eliminate the cap on the percentage of revenues that proprietary schools can receive from the Department of Education. . . .
Distance Education. H.R. 4508 would repeal the current-law requirement that online programs provide students with regular, substantive interaction with faculty. CBO expects that if programs do not need to meet that criterion they could more easily expand and scale up, resulting in higher enrollment. . . .
Short-Term Programs. Current law requires programs to offer at least 600 clock hours of instruction for students to be eligible for Pell grants. To be eligible for student loans, a program must offer at least 300 hours and have a student completion and placement rate of at least 70 percent. . . . H.R. 4508 would extend aid eligibility to students in short-term programs [and] there would no longer be any requirements about placement rates. . . .
Gainful Employment. In October 2014, the Department of Education published final rules related to gainful employment, setting benchmarks related to student income and federal loan debt that had to be met by programs at proprietary institutions...H.R. 4508 would repeal . . . gainful employment [rules]."
Indeed, it will be much easier to expand enrollment without the need to spend any money providing students "regular, substantive interaction with faculty," who can answer student questions, connect them with employers, or teach them.
November 29, 2017
Republican Education Bill Would Boost Profits for Private Student Lenders and Raise Financing Costs for Students (Michael Simkovic)
House Republicans recently voted along party lines in favor of a tax bill that specifically targeted higher education institutions and students for tax hikes, while providing large tax cuts for corporations and wealthy individuals. The Wall Street Journal reports that House Republicans are proposing an additional higher education bill that would make the terms of federal student loans less flexible and less generous and limit federal student loan availability. Specifically, the bill would eliminate Public Service Loan Forgiveness and reduce the availability of flexible repayment plans for all borrowers. It would also cap maximum borrowing from the federal government at a lower level.
These measures, if enacted, would be a boon to private student lenders like Sallie Mae, who would be able to both increase their prices and increase their market share as federal student loans become less competitive and less available. Consequently, expected financing costs for students will likely increase, to the detriment of both students and educational institutions.
According to a study by the Government Accountability Office and the Department of Education, loans to graduate and professional students are the most profitable in the government's portfolio--even after income based repayment and debt forgiveness. Capping loans to these attractive borrowers may reduce the overall profitability of federal student lending, and pave the way for arguments for more cuts to federal lending in the future.
The bill reportedly will also reduce regulation of for-profit college sales and marketing, and provide greater funding for 2-year degrees and apprenticeship programs. Labor economists who have studied 2-year degrees and apprenticeship programs typically find that these programs provide relatively low benefits (in terms of increased earnings and employment) compared to 4-year college degrees and graduate degrees, even after accounting for differences in the costs of these programs and differences in student populations. Thus, increasing funding for apprenticeships while reducing funding for 4-year degrees and advanced degrees is likely to impede economic growth.
These educational priorities, may however, provide Republicans with political advantages. Political scientists and pollsters have found that as education levels increase--after controlling for income, race, sex, and age--individuals become more likely to identify as Democrats and less likely to identify as Republicans. The association is particularly pronounced among scientists and others with graduate degrees.
November 17, 2017
Following up on my previous post, Republican Tax Hikes Target Education,
[U]nder the House’s tax bill, our waivers will be taxed. This means that M.I.T. graduate students would be responsible for paying taxes on an $80,000 annual salary, when we actually earn $33,000 a year. That’s an increase of our tax burden by at least $10,000 annually.
It would make meeting living expenses nearly impossible, barring all but the wealthiest students from pursuing a Ph.D. The students who will be hit hardest — many of whom will almost certainly have to leave academia entirely — are those from communities that are already underrepresented in higher education. . . .
The law would also decimate American competitiveness. . . .
Graduate students are part of the hidden work force that drives some of the most important scientific and sociological advancements in the country. The American public benefits from it. Every dollar of basic research funded by the National Institutes of Health, for example, leads to a $1.70 output from biotechnology industries. The N.I.H. reports that the average American life span has increased by 30 years, in part, because of a better understanding of human health. I’d say that’s a pretty good return on investment for United States taxpayers."
September 18, 2017
"Individuals who complete law school typically receive a large boost to their earnings compared to what they would likely have earned with a terminal bachelor’s degree. (Simkovic & McIntyre, 2014) The law earnings premium has exceeded the cost of law school by a wide margin, even toward the bottom of the earnings distribution, and even for graduates who enter the labor force during a recession or with an unusually large cohort of fellow law graduates. (McIntyre & Simkovic, 2017)
But is the value of a law degree predictably different depending on one’s race or ethnicity? Estimates by race or ethnicity could help prospective law students and law schools better predict variability in the potential financial benefits of law school, and could help inform outreach, admissions, academic support, and financial aid policies.
This article investigates differences in the law earnings premium by race and ethnicity. Compared to bachelor’s degree holders, a higher proportion of law graduates are white.
Studies of the returns to education at the college level or below have come to different conclusions about differences in benefits by race. Several studies have found lower earnings among black and Hispanic law graduates compared to non-Hispanic whites. The reasons for these differences are not fully understood and are hotly debated. . . .
Whatever the cause, among those with law degrees, there are differences in average earnings between different race or ethnic groups. However, the same pattern is present among bachelor’s degree holders. [Prior to this study it was] unknown whether there are similar differences in earnings premiums (i.e., the boost to earnings from the law degree), measured either on a percentage or dollar basis. . . .
[T]he National Longitudinal Bar Passage Study found that long-term bar passage rates were substantially lower for minorities than for whites. Thus a study of all law degree holders including those who did not pass a bar examination [such as this one using Census data] may find larger racial gaps in earnings [than previous studies that look only at bar-passers].
We find evidence that white graduates have a somewhat higher percentage boost in earnings compared to minorities, but when translated into dollar terms the law earnings premium is substantially higher for white graduates than for minorities. At the median and including law graduates who are not practicing law, the annual boost to earnings from a law degree is approximately $41,000 for whites, $34,000 for Asians, $33,000 for blacks, and $28,000 for Hispanics. The law earnings premium is also higher for whites than for minorities at the 75th percentile, the 25th percentile and the mean, and for samples that are exclusively male or female. . . .
September 09, 2017
New American Foundation fires a prominent researcher who criticized one of its largest donors (Michael Simkovic)
The powerful Washington D.C. think tank New America Foundation, which has ties to the technology, finance, and aerospace industries, recently fired a researcher within days after the researcher praised the European Union for fining Google for antitrust violations. Google and its CEO are among the largest donors to New America Foundation, as well as other think tanks. The head of New America Foundation claims the firing was for a lack of collegiality, but declined to discuss specifics.
The firing echoes similar incidents at other think tanks, including the American Enterprise Institute and Brookings Institute, where researchers have been fired shortly after offending other important donors or political patrons.
As the Economist magazine explains:
[Think tanks suffer from] a fundamental flaw. Unlike other institutions designed to promote free inquiry, such as universities or some publications, think-tanks do not enjoy large endowments, researcher tenure or subscription revenue to insulate thinkers from paymasters. And thinking costs a lot.
The New America Foundation has played a prominent role in efforts to privatize student loans by making the terms of federal student loans less attractive and making the loans less widely available.
August 25, 2017
Todd Henderson (Chicago): Lawyers make better CEOs in industries with high litigation risk (and worse CEOs elsewhere) (Michael Simkovic)
Professor Henderson finds that: "CEOs with legal expertise are effective at managing litigation risk by, in part, setting more risk-averse firm policies. Second, these actions enhance value only when firms operate in an environment with high litigation risk or high compliance requirements. Otherwise, these actions could actually hurt the firm."
August 21, 2017
Vanderbilt Tax Professor Herwig Schlunk wants the federal government to tax university endowments, preferably out of existence. He writes: “In the best of all possible worlds, the federal government could and probably should . . . confiscate[e] all private university endowments . . .”
Toward that end, Schlunk recycles arguments that were discredited years ago.
Professor Schlunk is famous for asserting that law school is a bad investment. Schlunk’s bold claim—based on back of the envelope calculations and highly unscientific website surveys—was popularized by the Wall Street Journal and echoed by sympathetic media outlets. Peer reviewed research by labor economist Frank McIntyre and me—using high quality nationally representative government data and well-established econometric techniques—subsequently demonstrated that Schlunk was mistaken. (See here and here).
This post critiques Schlunk’s recent work on endowments for misuse of discount rates, overlooking the importance of educational quality, mismeasuring student earnings and higher education expenditures, selectively targeting higher education, supporting policies that undermine economic growth, and overlooking stark differences between popular votes and political power.
Misuse of discount rates
To arrive at his headline-grabbing law school result, Schlunk relied on some spectacularly unrealistic assumptions. As Frank McIntyre and I explained four years ago:
“Professor Schlunk’s analysis assumes astronomical discount rates, low earnings growth rates, and zero inflation for thirty-five years. None of these assumptions are empirically or theoretically justifiable.
Most studies [of higher education] by economists have generally used a discount rate between 2.5% and 3%. . . . Compared with the 3% discount rates applied in labor market studies by economists and suggested by the real (net-inflation) costs of financing a law degree . . . Professor Schlunk applies real discount rates of between 8% and 27%.
If Professor Schlunk had used comparable assumptions about discount rates to evaluate the value of a college degree compared to a high school diploma, he would have reached the conclusion that few should go to college. Indeed, given a 30% nominal discount rate, whether it makes financial sense to complete high school might be debatable.”
Undeterred, Professor Schlunk once again relies on unrealistically high discount rates and overlooks differences in completion rates, this time to argue that private non-profit universities provide little value when compared to leanly funded, politically vulnerable public universities. Based on this analysis, he concludes that the federal government should tax universities more heavily than it already does. Higher discount rates mean that future cash flows have a lower present value. Thus the value of a lifetime of higher earnings from higher quality education is diminished by choosing a higher discount rate.
Schlunk’s justification for using such high discount rates is that higher education “puts me in mind of income streams I confronted when advising investors in the private equity sector [where] discount rates of as high as 30% were generally applied.”
For the record, peer reviewed research generally finds that private equity returns net of fees are close to or less than those that can be found in the stock market—not remotely close to the 30 percent returns assumed by Schlunk. (In addition, discount rates are supposed to reflect the weighted average cost of capital, NOT the (higher) returns to equity). If P.E. investors were applying high discount rates to cash flow projections, this likely means that investors believed that P.E. cash flow projections were over-optimistic.
Overlooking college completion rates
In his latest critique of higher education, Schlunk also overlooks large differences in completion rates. Four-year completion rates for bachelor’s degrees are almost twice as high at private non-profit universities as at their more leanly funded public counterparts. If one accepts Schlunk’s assumptions of extremely high discount rates, even a modest delay in completion would have a dramatic impact on value.
Overlooking effects of increased educational expenditures and educational quality
Peer reviewed studies that control for differences in student characteristics consistently find that higher expenditures per student lead to significant increases in student earnings and likely contribute to higher completion rates. (For brief reviews of the literature, see The Knowledge Tax and Populist Outrage, Reckless Empirics; See also here).
Professor Schlunk overlooks these studies.
Mis-measuring student earnings and educational expenditures
Schlunk overestimates the difference in expenditures and resources at elite public and private universities, which leads him to over-estimate the earnings premiums necessary for more resource-intensive private education to be worthwhile. Schlunk assumes incorrectly that all students at elite flagship state universities pay low in-state tuition, when many students at these institutions pay much higher out-of-state or international student tuition. He overlooks the extent to which expenditures per student at elite public universities exceed in-state tuition because of state subsidies and cross-subsidies from out-of-state students. He overlooks the extent to which differences in financial aid affect net-tuition—and therefore educational resources and expenditures—at different universities.
The elite public universities that Schlunk presents as controls that he sees as similar to private universities, but without endowments, actually have larger endowments than many private universities.
July 31, 2017
Focus group of California lawyers defends tight restrictions on entry into the legal profession (Michael Simkovic)
California is an extreme outlier in the extent to which it restricts entry into the legal profession compared to other U.S. jurisdictions. Two examples of this include an unusually high minimum cut score on the bar exam and a refusal without exception to permit experienced licensed attorneys from other jurisdictions to be admitted without re-examination.
California lawyers are relatively highly paid, and relatively few in number considering the size of the workforce in California. Restrictions on entry into the profession may help maintain this status quo. There are serious questions about whether this protects consumers, or is economic protectionism. Economic protectionism could benefit California lawyers, but it would likely also harm consumers of legal services by making legal services less available, more expensive and perhaps lower in quality because of reduced competition. Protectionism would also reduce economic opportunity for those denied the option of practicing law in California, much as immigration restrictions deny economic opportunity to those excluded from high-income countries.
The Supreme Court of California, concerned about the anti-trust implications of a licensed profession establishing criteria for entry, instructed the California State Bar to prepare recommendations on revising the California bar cut score.
Stephen Diamond reports that the California State Bar recommended that its bar examination should either stay the same or be made even harder.
The California Bar arrived at this conclusion by asking a panel of California lawyers how hard the bar exam should be. To be more specific, panelists read essays, categorized them into good, medium and bad piles, and, with the assistance of a psychologist who specializes in standardized testing, used this categorization to back-out an extremely high recommended bar passage score.
Finding that people with high multiple choice scores also tend to write better essays is about as surprising as finding that cars that Consumer Reports rates highly are also often highly rated by J.D. Power. It's also about as relevant to the policy decision facing the California Supreme Court about minimum competence to practice law.
The relevant question for restricting entry into the legal profession is not whether good (and presumably expensive) lawyers are better than mediocre (and presumably more affordable) lawyers. Rather, the relevant question is when consumers should be able to decide for themselves whether to spend more for higher quality services or to save money and accept services of lower quality. Most people will agree that a new Lexus is likely a better, more reliable and safer car than a similar-sized used Toyota. But this difference in quality does not mean that the government should banish used Toyotas from the roads and permit to drive only those who are willing and able to buy a new Lexus.
Is there evidence that a bar examinee who would be permitted to practice law in Washington D.C. or New York or Boston or Chicago, but not in California, would routinely make such a mess of clients' affairs that California clients should not even have the option to hire such a lawyer?
Is there evidence that consumers of legal services cannot tell the difference between a good lawyer and a dangerously bad one?
If these problems exist, could they be addressed by simply requiring lawyers to disclose information to prospective clients that would enable those clients to judge lawyer quality for themselves?
The California Bar has not yet seriously addressed these questions in arriving at its recommendations.
The California Bar also reported that other states have sometimes recommended increases or decreases to their own bar examination cut score. But these states are almost all starting with much lower bar cut scores than California's baseline. It appears that few if any other states recommended bar examination cut scores as high as California's.
June 23, 2017
Least educated county on Oregon's Pacific Coast shuts its last public library rather than increase taxes by $6 per month per household (Michael Simkovic)
Douglas County in rural Oregon recently shut its last public library rather than increase property taxes by around $6 per month per household. Less than 16 percent of the population of Douglas County has a bachelor's degree or above, making it the third least educated county on the Pacific Coast of the United States and the least educated coastal county in Oregon.
Across the Pacific, cities like Singapore, Hong Kong and Shanghai have built globally competitive workforces by investing heavily in education and infrastructure and embracing global trade. In the United States, excessive anti-tax movements have contributed to disinvestment and have slowed U.S. economic growth.
Update: Michelle Anderson (Stanford) and David Schleicher (Yale) debate policy responses to local economic decline and migration of educated populations away from depressed areas. Hat tip Paul Diller. (Willamette).