TCS Daily

An Ownership Society with Opportunity Through Tax Loans

By Tom Grey - October 18, 2004 12:00 AM

Politicians are drug pushers, voters are drug addicts, and the drug of choice is OPM -- Other People's Money. Free money. Money from the government. Politicians say there's always more available: more for education, for retirement, for housing, for health care. Political signs say "vote for me" but mean "I'll give you more cash." This addictive behavior is explained by the Two Things of Economics:

1. There's no such thing as a free lunch.

2. Incentives matter.

Voters know that somebody has to pay -- their big incentive is to have the state pay, to use Other People's Money. Taxpayers know it is urgent to kick this habit, but how? Yes, cutting taxes, cutting the supply of money to the treasury. But while cutting taxes is popular, the more difficult need is to reduce demand. Americans, Slovaks, the entire democratic world, need a policy to reduce the demand for more state cash. What's needed is a demand reduction program, starting with higher education.

The government should give people loans instead of grants. One's loans are repaid by one's own future money. Loan money is your own money, but shifted in time. When a borrower accepts a state loan, taxes paid would be loan repayments -- hence Tax Loan -- with an extra loan repayment surcharges. The loan provides the opportunity, the taxes plus surcharge repays the loan, and the surcharge provides the demand reduction.

Tax Loans solve the financing problem for poor people, replacing Robin Hood's gifts to the poor. Paying for higher education is a big expense everywhere. Students often don't have the money or opportunity to buy the best education. The usual solution has been some state transfers to Universities, allowing admission of students who pay little or no tuition (especially children of the elite). Instead, that same amount of money should be distributed through individual Tax Loans, to the same students. Tax Loans could be much larger than the current Federal Loan programs, while using taxes to repay the loans increases the transparency, and reduces default.

Investing in an education then emulates business investment cycle -- borrow money, invest, and repay through that famous return on investment. The contractual agreement would specify how much money is borrowed, and how it is to be repaid. Just like a real loan. Students who take out Tax Loans become investors in their own human capital, owners of their own education.

A general sample Tax Loan for university education:

- The US government offers all students the possibility to borrow up to $18 500 / year for tuition and living expenses at college (current direct Stafford Loan amount).

- As the borrower pays income taxes, their tax payments will be loan repayments.

- After graduating (or four years), and until the loan is repaid, the borrower pays an additional loan surcharge - the borrower pays more than taxpayers making the same income without a tax loan balance.

-The IRS reports on the outstanding loan balances, and charges interest as on any unpaid tax.

A four-year $72 000 loan, repaid by taxes plus a loan surcharge, has advantages to most interest groups:

Students: more money available; more choices on where and how to invest it.

Government: higher amount of revenue through the loan surcharge payments, loans become self-financing.

Schools and teachers: more tuition money immediately available to the schools for upgrading / increasing teacher resources.

Where does today's extra money come from? From the future disposable income of the graduates, the future 'profit' from the educational investment, the loan payment surcharges. The individuals who invest and own their education are exactly those who pay more than they would under the current system.

A (simplified) repayment: A graduate who makes the average $36 000/ year, pays some 20% in income taxes $7 200. Add a 10% income loan payment, $300/ month ($3 600), and this loan surcharge becomes the additional money -- contractually and voluntarily agreed to. The income tax and loan payments total $10 800 -- so it takes some 7 years to repay the loan, depending on income, longer with interest.

Such a program could start at the federal level, and expand to include states to replace the state's education expenses. The World Bank could fund such programs in the developing world -- it is clear that flat rate tax countries like Russia, Estonia, and Slovakia would be excellent candidates for this.

In democracies, politicians push the addiction that voters demand -- OPM. Reducing the demand for benefits requires a philosophic shift. A Tax Loan, instead of a grant, provides this different philosophy. "Giving a hand," a loan, "not a handout".

Tom Grey is a senior advisor to the F. A. Hayek Foundation in Slovakia. Living in Slovakia since 1991, he has also been an advisor the government, but works primarily in the private sector.


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