How to Finance Higher Education?

˙ PREAL Blog

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Higher education has changed dramatically in the last forty years. What was the privilege of rich nations or poor countries’ elites is now an integral part of international competition and development strategies. According to The Economist, the “global tertiary-enrolment ratio […] went up from 14% to 32% in the two decades to 2012; in that time, the number of countries with a ratio of more than half rose from five to 54.” (May, 2015).

Countries have responded to the challenge of funding mass higher education in various ways. One constant in these processes is the reluctance to make changes in the status quo that could trigger political backlashes from current stakeholders. Yet, while some European countries with a small private sector and a tradition of selectiveness (e.g. Germany) have been recently able to return to the tuition-free model, the rising costs have forced compromise almost everywhere else. The existence of tuition fees has become the norm in countries that were reluctant to charge for higher education, like Australia and England. Similarly, countries that relied strongly on private sources, like the United States and Chile, have increasingly used public funding to avoid the financial overburden of their students.

This tendency to combine different sources of funding can be found in two promising mechanisms that allow countries to fund higher education ‘free at the point of delivery’ with limited fiscal costs: the Graduate Tax (GT) and the Income Contingent Loans (ICL). The GT is a proportional tax levied on college graduates destined exclusively to finance higher education. The ICL is a credit system in which students pay their debts contingent on their income. Although no country has adopted a GT scheme, ICL have gained popularity in countries like the US, Australia, and Chile, among others. For example, the number of students financing their studies with some form of ICL in Chile has increased at an average annual rate of 21% since 2006, reaching roughly 40% of students in 2015. Similarly, according to the Department of Education, in the U.S. the number of income-contingent loan recipients has tripled in the last three years.

The GT and the ICL are politically attractive because they have the potential to benefit both students and taxpayers. However, they have different ideological foundations and can be easily aligned with opposite sides of the political spectrum. On the one hand, the GT is advanced under the premise that those who earn more will contribute more and it is usually associated with the rhetoric that higher education is predominantly a public good. On the other hand, the ICL is consistent with the logic that each student should pay for what he or she receives; it fits the rhetoric that the benefits of higher education are primarily private. In practice, the most important difference between the two is that the GT generates common-pool funding based on progressive contributions that are then distributed according to politically-determined criteria, while in ICL each student pays for the education she received according to market prices but limited to a percentage of her income.

Though the GT and the ICL can be compared in several dimensions, such as efficiency in social welfare provision, demand for regulatory infrastructure, room for institutional autonomy and institutional development, allocation of financial risks or fiscal costs, to mention some examples, our objective here is to compare them in terms of fairness. We chose fairness because the GT has been defended as progressive policy able to materialize higher education ‘as a social right’ that can benefit the poor. We explore whether this holds true when compared to the ICL. Is the graduate tax truly progressive? If so, what kind of solidarity does it offer?

In a preliminary study (Barroilhet, Espinoza, and Urzúa, 2016), we simulate and compare both mechanisms in the Chilean context using data provided by the Ministry of Education on student enrollment, tuition, and expected salaries for a broad range of degrees. Our findings show that the GT becomes extremely problematic when the academic programs to be financed have different durations and grant degrees that are recognized and rewarded differently by labor markets. In such a setting, GT’s progressiveness, measured over students’ wealth, fades away and actually tends to harm poorer students, on average. This is partially explained by the fact that, even in the absence of tuition fees, poorer students tend to seek shorter degrees, such as technical degrees, which are cheaper to provide and give them more immediate monetary rewards. For instance, in Chile, students from low socio-economic status (SES) pursue programs that are on average 1.5 years shorter and whose annual tuition fees are roughly 40% less than those from high SES. The early entrance to the job market – with immediate but limited wages – places the poor in the situation of having to pay the GT for life for an education that was relatively cheap to provide.   

In contrast to poor students, rich students face no pressure to enter the job market early and can choose longer and more-expensive-to-provide programs that allow them to opt for higher wages. Unlike the poor, rich students start to pay the GT later for an education that was relatively more costly to provide. Our data shows that high-SES students enroll in programs in which total tuition is 250% higher than those from low-SES students.  

The counterintuitive result of creating a common pool resource based on proportional contributions that nevertheless harms the poor occurs because the GT cannot upset the benefit-wage imbalance. Put simply, because the GT provides benefits detached from costs and such benefits vary greatly according to market rewards, the groups that are able to get into the more expensive and longer programs that are later better paid end up benefiting, on average, much more than the rest. Our study shows that, when using current tuition and expected salaries, a GT would benefit 45% of students who graduate from private schools (high-SES), while it would only benefit 15% of those who graduate from public schools (low-SES).

If a progressive policy is one that increases economic equality among individuals or groups that contribute and/or benefit from the policy, then the GT is on a tight spot. The GT only has the potential to be progressive when there is little dispersion on graduates’ wages, and when the benefits of the policy cover tuition and all the other needs that make poorer students choose shorter and cheaper programs. Yet the former is hard to come by and the latter is expensive to the point of limiting the state’s ability to raise revenue for other social policies. The absence of either of these two elements makes a strong case against implementing the GT as a mechanism to fund mass higher education. The GT is a risky and potentially inequitable policy when compared to alternatives like the ICL, which also facilitates access and, on average, can favor the poor, as our research shows.


Agustín Barroilhet is a S.J.D. Candidate at Georgetown Law Center.

Ricardo Espinoza is a Ph.D. Candidate in Economics at the University of Maryland.

Photo credit: Cedim News / Flickr / CC BY-NC 2.0