Paul L. Caron

Friday, July 19, 2013

What Is the Economic Value of a Law Degree -- $1 Million or $100,000?

One MillionFollowing up on my prior posts (links below):  Paul Campos (Colorado), If I Had a Million Dollars:

The legal internets are atwitter with talk of a new paper which suggests that a law degree is worth a million dollars. It’s an interesting exercise in econometric advocacy, and I’m going to spend some time analyzing the authors’ claims.

I’m going to proceed in two parts. First, I’m going to assume for the purposes of argument that the paper’s interpretation of its data is correct in regard to the value of law degrees acquired in the past, and that, as they argue, there is no good reason to assume this value will not be maintained in regard to law degrees acquired in the future. Then I’ll critique those assumptions.

Simkovic and McIntyre estimate “the mean pre-tax lifetime value of a law degree as approximately $1,000,000.” ... The authors estimate that the median post-tax value of a law degree is (or has been, which they treat as the same thing) $420,000. Since they assume a working life of 42 years, they are in fact estimating that for the median graduate a law degree generates a $10,000 annual income premium (in 2012 dollars) over what an otherwise similar college graduates who choose not to go to law school could expect to earn over the course of their lifetimes. That still sounds like a pretty good outcome, even if it’s not nearly as spectacular-sounding as the headline-grabbing million-dollar claim.

Yet the wary reader will have noticed a striking omission from the argument so far: how much is it going to cost a law graduate to generate this premium? ... Recall that the authors estimate the median post-tax value of a law degree as $420,000. How much will the typical law student end up paying, in principal and interest, in order to make this investment? The answer is $444,150. ... 

Does this mean that, even assuming the authors’ claims about the income premium generated by a law degree are actually correct, a law degree will have negative net present value for the typical matriculant in the class of 2013? Not quite. This is because the authors discount the hypothetical future earnings of current law students to present value. So – again, granting the accuracy of all of their data and methods – the present value of a law degree for people now enrolling in law school would be the difference between $420,000 and the negative net present value of a legal obligation to amortize $200,000 of debt at 7.5% interest over the next 25 years.

What this latter figure is depends on various assumptions about future rates of inflation and the like, but, given recent historical trends (inflation has been considerably less than half of the interest rate law students must pay on their debt), it’s reasonable to assume that the negative net present value of this obligation is somewhere around halfway between the present payoff cost of the debt and the total future income stream necessary to amortize it under its terms. (The authors use a real discount rate of 3%, which is congruent with this assumption).

In other words, if we give the authors’ analysis every possible benefit of the doubt, we would conclude that, after including the cost of the investment in the analysis, the typical pecuniary premium generated by a law degree acquired by matriculants in the class of 2013 will be $2,619 per year in constant 2012 dollars, or $218.25 per month about $109,000 (On reflection I think the deleted numbers are wrong, because they end up discounting the increased earnings inappropriately. The $109K number represents net present value after subtracting the net present negative value of the investment cost, discounted at the same rate as the higher earnings).

Update:  Stephen F. Diamond (Santa Clara), Man Bites dog: “Bad Cop” Law Prof Paul Campos, Leader of Anti-Law School Camp, Backs New JD Value Study:

In the world of corporate finance there is a very simple decision rule: managers should accept all positive net present value (NPV) projects. This is a very simple and powerful concept. It lies at the heart of how we train managers at every business school in the world. ...

[Paul Campos] has simply done exactly what the paper implies all analysts of the value of a JD should do – apply relevant costs such as potential debt and taxes and subtract those from the expected and discounted future cash flows. Sure enough, even with his inputs (like the implication that students must borrow $200,000 to go to law school) the result Professor Campos comes up with is a NPV of $109,000, i.e., positive. ...

Now return to what I said at the outset: managers – in this case the managers are prospective law students “managing” their own human capital – should accept a project with positive NPV. In other words, even under Campos’ analysis the conclusion that a student should reach is that law school makes sense. The actual net dollar amount above present value is irrelevant as long as it is positive. ...

So, far from undermining the Million Dollar JD Value paper, Professor Campos simply confirms its fundamental insight: law school is a positive net present value project for the vast majority of law students even when tested by the institution’s leading opponent.

Prior TaxProf Blog coverage:


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"Maybe one reason for the crisis in legal education is that so many professors seem to be spending their time discussing the crisis in legal education?"

Wait, aren't you a law professor discussing the crisis in legal education on a Saturday morning in July?

- One of America's tens of thousands of un/underemployed attorneys, who will need to get a job at Goldman Sachs or McKinsey in order to see $1 of earnings premium that will not go to mountains of student loans and interest upon them

Posted by: Unemployed_Northeastern | Jul 20, 2013 9:03:37 AM

Maybe one reason for the crisis in legal education is that so many professors seem to be spending their time discussing the crisis in legal education?

Posted by: michael livingston | Jul 20, 2013 6:46:16 AM

Eric, I'm working off the assumption that the correct calculation is to take the median projected educational debt of 2013 law school matrics paid out over 25 years at 7.5%, discount that by 3%, which is S&M's real discount rate, and then subtract that figure from their discounted present median value after taxes. That yields a present value of $109K. I deleted the yearly increased earning calculation, because as Paul Caron suggested to me that involves double discounting.

Posted by: Paul Campos | Jul 19, 2013 3:16:47 PM

Prof. Campos is confused. Simkovic and McIntyre aren't just adding up the wage premiums over the years. They are computing the "present discounted value" of the wage premiums--- that is, using a particular discount rate (they use 3%), what sum of money received now is worth the same as the wages premiums received at various points during the years. Thus, the $420,000 is indeed what should be compared with the present cost of law school. If tuition plus foregone earnings for 3 years is $200,000, then the net present value of a law school education is $220,000.

I think they found the average wage premium was something like $50,000/year, but because the biggest wage gains are late in life, the present value is less than $50,000 times the number of working years.

The discount rate chosen is highly important to the result, and it is hard to know the proper discount rate. They used 3%, after inflation. Campos seems to agree that this is a good choice for after-inflation return.

Posted by: Eric Rasmusen | Jul 19, 2013 2:58:24 PM