TaxProf Blog

Monday, July 22, 2013

Diamond on The $1 Million Value of a Law Degree

Following up on my prior posts (links below): Stephen F. Diamond (Santa Clara): The One Paper Every Law Professor and Law School Dean Should Read This Summer:

While the personal motivations of these law faculty “critics” with respect to law school itself may be difficult to explain, the nature of their core argument is much easier to understand. They have been artful and persistent in contending that the real meaning of the recent downturn in legal employment is that the American law school is based on an “unsustainable” business model.

Because of the surrounding macroeconomic crisis – which, like a one hundred year storm swept up everyone in its path – separating cause and effect with respect to this model has, in fact, been very difficult. The anecdotal data appeared to be very much on the side of the critics. After all, with even the most prestigious law firms laying off partners and the most prestigious law schools reporting difficulties for their graduates in the job market it was very hard to consider the possibility that what was happening was, in fact, the result of the inherently cyclical and volatile nature of modern capitalism. ...

A new paper, peer reviewed prior to its presentation to the 2013 American Law and Economics Conference at Vanderbilt, provides concrete data upon which to judge the sustainability of the law school model. ... The good news is that, yes, the recent crisis is cyclical not structural; yes, law school represents a worthwhile investment for a substantial majority of students who earn JDs; and, therefore, as a general matter, law schools and their university administrations should be very cautious about taking drastic action in response to the recent pressure created by the downturn in law school applications.

The reason one can draw these general conclusions is that through careful empirical work the authors are able to track the lifetime earnings premium that holders of JDs win over those students who hold only BA degrees. Their estimate is that at the mean this premium is worth $990,000 for JD holders and at the median is worth $610,000. These figures do not include taxes or tuition although they do include the cost of living incurred while attending law school. After deducting for tuition, however, it is the authors’ conclusion that “for most law school graduates, the net present value of a law typically exceeds its cost by hundreds of thousands of dollars.” Deducting taxes lowers that outcome, although it remains positive for most law students and, the authors argue, “may dramatically increase” at the lower end of the distribution with the availability of debt forgiveness or IBR type programs.

Of course, an institution such as the American law school that can produce graduates who attain such a substantial financial advantage over their non-law school BA colleagues can easily maintain a sustainable business model.

It is important to stress two important aspects of the study that one should keep in mind when considering this paper against the arguments of the law school critics:

this paper is based on a large data set from the U.S. Census Bureau over a long period of time (1996-2011) and thus is the first thorough effort (that I can find) to consider the sustainability of earning a JD without relying on anecdotal information; and

the authors conclude and, in my view clearly demonstrate, that the recent difficulties for JD holders were generated by a cyclical downturn in the wider economy and not by some kind of unique event that hit the legal profession in a manner not experienced by every other profession; and perhaps of greater importance the study’s data clearly show this downturn is over now and the earnings premium of JD holders has now turned upward consistent with its behavior over many years and in spite of the ongoing, if short term, difficulties of recent JD holders (the data on earnings is carried through 2011 for all JDs who graduated from 1996 through 2008).

Now, however, with actual verifiable data in front of us, it is clearer that the challenges facing recent JD graduates and now law schools are consistent with the long term cycles of the wider economy. In fact, the decline in the earnings premium of JD holders in the wake of the dot com crash in 2000-01 was steeper and deeper than what was experienced by JD holders after 2008. Yet the earnings premium recovered and increased substantially for the next several years, then turned downward (but retained an advantage over the BA) and has now turned upward once again. Thus, the authors conclude that the “law degree earnings premium is stable over the long term, with short term cyclical fluctuations.”

The following chart illustrates this:

The authors are sceptical as well that anything has occurred in the last few years that suggests some kind of unique “neutron bomb” like event has hit the legal profession that did not also hit the rest of the economy. Thus, the relative significant advantage of a JD, across a wide range of income levels (i.e., for JD holders at both the 75th and 25th percentile of lifetime earnings – see chart below), persists.

In short, for most JD holders law school has made sense for a very long time and it continues to make sense today.

Nonetheless, while the economic recovery helping the earnings premium turn upward again is taking hold, it is doing so slowly and so the job market for many graduates remains a challenge. While eventually the market will absorb these talented and hard working and highly trained JD holders and in light of past experience they will do well, their shorter term plight is impacting the attractiveness of law school to new applicants. In addition, as the economy recovers there are more opportunities for BA holders and so larger numbers are staying away from what may appear to be a higher risk effort to enter law school. That actually may hurt recent JDs who have not found work as lawyers because they are competing for similar jobs with those BA-only candidates. Over time, the added value of the JD will take hold if one accepts the results of the authors but it will take time. The following chart illustrates the earnings curves for both groups over a lifetime:

This means, of course, that for many law schools there are significant pressures with respect to enrollment. Schools that were too aggressive during the period prior to when the recent crisis took hold will be under pressure to meet their costs. That may mean some difficult conversations with University Provosts, Presidents and even Trustees. Thus, it is a good idea for law school faculty and deans to absorb fully the conclusions reached in the Simkovic/McIntyre paper.

If a law school or university panics and makes significant cuts based on the propaganda and anecdotal data pushed on them by those who have another agenda, they could be making very serious mistakes. The human capital that a university builds up and the goodwill it accumulates can disappear very quickly. As Warren Buffett once remarked, ”It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.” ... It is, thus, very fortunate that the American law school now has a data-based objective picture of the overall economic value of the JD project.