The IRR of going to university

Going to university has become a bit of a contentious issue in recent years, especially in countries like the US or the UK where students are graduating with large debt burdens and face uncertain job prospects depending on the subject they have chosen. Time then to perform an economic analysis of the internal rate of return of going to university in the US.

Jack Mountjoy (yes, that’s his name; I am jealous) examined the lifetime earnings and taxes paid by university graduates from Texas. He compared students who were narrowly accepted at a Texas University with students who were narrowly rejected. The rejected students then might have gone on to study in a different state, study for a two-year degree instead of a four-year degree, or may not have gone to college at all. By comparing the people who managed to get into university with those who barely missed out, Mountjoy was able to calculate the marginal return on investment for going to university.

What the research showed was that marginally admitted students on average complete one more year of study than marginally rejected ones and are 12% more likely to earn a bachelor’s degree. The lifetime earnings power of marginally admitted students is some 5-10% higher than that of marginally rejected ones.

Here is a list of all the costs and benefits that accumulate for students, society as a whole, and taxpayers without discounting them to the present day.

Undiscounted cumulative costs and benefits

Source: Mountjoy (2024)

The benefit to the individual is given by the post-tax earnings from employment. This is initially negative because students receive government tax subsidies, grants, etc. but once out of college, they earn money and dig their way out of their holes quite fast. Taxpayer benefits are the tax revenues earned from these students which initially are zero or close to zero and only accelerate once the graduates are further in their career and have higher incomes. The benefits to society overall are simply the combination of taxpayer and individual benefits.

The costs to students of going to university are remarkably low, mostly because the marginally accepted students almost always qualify for student loans or government grants and other support measures so that tuition fees are nearly perfectly offset. Meanwhile, the costs to society accumulate because a university education costs money and if the students don’t pay for it, others have to. After four years, when students graduate, the costs stay constant as no new costs are accumulated for the student.

But these are undiscounted cumulative costs and while it is obvious that students benefit after eight years (student benefits outweigh student costs) and society overall benefits after 12 years, the true assessment of the value of a university must be made by discounting these costs and benefits to the present day. Below is the chart with the present value of costs and benefits at different discount rates.

Present discounted costs and benefits

Source: Mountjoy (2024)

Comparing costs to benefits, the analysis shows that the IRR (the discount rate at which benefits outweigh costs) is in the order of 20% for the individual. Or to put it in layman’s terms. Going to university is one of the best investments you can make as an individual ever – even in the face of high tuition fees. From a societal perspective sending people to university also remains a good investment with an IRR of 10-12% even in these marginal cases when society carries almost all the costs of educating the students. Obviously, this is an analysis of the current situation. If you send more and more people to university, the IRR declines because the supply of university graduates increases while demand stays roughly constant. But this study shows that as of today, we are not at the point where going to university has become worthless. Quite the opposite, for society, sending someone to university is still a highly attractive proposition.

The IRR for the taxpayer, however, is rather low at 3-4%. This is because on average only 20-25% of the earnings of graduates accrues to the taxpayer in the form of income taxes. The higher the income tax rate, the higher the IRR of a university education for the taxpayer. And the lower the tax rate, the less profitable it is for governments to encourage people to go to university.

But what do I care about taxpayer IRR? To me, the bottom line is that even if you ignore all the benefits of getting a university education in terms of cognitive capacity and acuity (e.g. the ability to think logically and make a coherent argument, the knowledge of history, and other things depending on the chosen degree) university is well worth it. Even if you look at it just as an economic endeavour, going to university is about the best investment anyone can make in their life.