To students, Uncle Sam’s a loan shark
One of the odd things about borrowing money when you go to college is that you borrow the money when you don’t have enough income to pay taxes. When it comes time to pay back the money, however, you’ll have to pay a tax on every borrowed dime. So Uncle Sam makes out quite nicely when your education “pays off.”
Let’s take a more detailed view. If you are a college or professional school student, it’s likely you’re single. The personal exemption amount for 2016 on a single filer is $4,050. The standard deduction is $6,300. That totals $10,350. You can earn that much before you have a federal income tax bracket. After that, you can earn another $9,275 and still pay federal income taxes at only 10 percent.
Things are different when you graduate and start your working career. With an average starting salary of $50,651 last year, a typical college grad, still single, broke into the 25 percent tax bracket. It starts at a taxable $37,651. If they earn more than the average amount, as most hope, they will be well into the 25 percent tax bracket.
Starting salaries for recent graduates are not one-size-fits-all. Go into public school teaching, and you can be pretty sure that your marginal tax rate — the rate you pay on the highest dollar earned — will be 15 percent. Get a degree in computer science, engineering or mathematics and statistics, and the average starting salary will be $60,000 or more. Get a computer science or electrical engineering degree from Carnegie Mellon, Caltech, MIT or Stanford, and starting salary will be nudging $90,000 to $100,000. That’s well into the 25 percent tax rate.
That’s nice. So going to college makes sense.
The hard part comes when the graduate has to pay the borrowed money back. Why? Because it is done with after-tax income. While interest payments up to $2,500 a year may be deductible, principal repayment is not. So if you are in the 66 percent who graduate from a public college with debt and have average debt, you’ll owe $25,550 of after-tax income. With a marginal tax rate of 25 percent, that means you’ll pay back $34,067, a nice $8,517 premium for Uncle Sam.
The actual figure is higher, however. Everyone has to pay the employment tax on the same income. Add the 7.65 percent (employee portion) tax, and the marginal tax rate is 32.65 percent. The pretax income that you need to earn jumps to $37,936. So Uncle Sam gets a nice $12,386 premium on your education. Basically, our government takes in a tax premium of nearly 50 percent of the cost of education as part of providing the loans — and this doesn’t consider a dime of the interest expense.
Students who graduate from private nonprofit colleges and universities must pay the same premium on their larger average loan debt of $32,300. The same applies, in spades, to professional degrees. According to the studentloanhero. com website, the combined debt of the average law school graduate is $140,616; a medical school graduate has an average combined debt of $161,772.
Now let’s do a back-ofthe-envelope calculation. According to the student loan debt clock, the current level of student debt is $1.435 trillion. So if Uncle Sam pulls in taxes on this amount, the total students will have to pay back, tax premium included, would be $2.13 trillion. Again, that’s an added tax premium of nearly 50 percent, about $700 billion.
Do you get the feeling something is wrong with this picture? Today, under Section 179 of our tax code, a small business can deduct as much as $500,000 for the purchase of capital equipment, new or used. That’s an immediate deduction against income. This means a smallbusiness owner can deduct all kinds of computers, tools, equipment, trucks, etc., because our tax law allows us to depreciate the capital used to generate income.
But education creates human capital. Wouldn’t it be nice if we had a smart government, one that treated higher education as a depreciable investment? It would shrink (but not eliminate) a growing student debt crisis. It would give young workers a better start.