Three Misconceptions About the Economy That Should Die

Popular ideas that just ain't so.

Sep 3, 2014 at 9:41AM

The world would be a better place if we stopped telling ourselves a few things.

We should stop saying that college tuition has increased at three times the rate of inflation. Saying so is at best incomplete, and more often it's totally wrong.

While the sticker price of tuition has indeed ballooned over the last two decades, so have grants and scholarships.

According to the College Board, the annual sticker price of attending a private four-year college increased from $17,040 in 1992 to $29,060 in 2012, adjusted for overall inflation. But grants and scholarships more than doubled during that period. On net, the median annual cost of attending private college went from $10,010 in 1992 to $13,380 in 2012, meaning the amount students actually paid grew half as fast as the sticker price suggests.

Ditto for public four-year schools. The sticker price of tuition was $3,810 in 1992, and $8,660 by 2012, adjusted for overall inflation. That's a gain of 4.2% per year. But the actual amount students paid went from $1,920 to $2,910, or an annualized gain of 2%. Adjusted for grants, the inflation-adjusted cost of two-year college has actually declined over the last 20 years.

Why would schools balloon the sticker price but make it up with scholarships? A lot of it is marketing. If I say, "Billy, tuition is $20,000 a year," it sounds high. If I say, "Billy, tuition is $40,000 a year, but we'll give you a scholarship to bring it down to $20,000," it's an offer he can't refuse. There's also a rich student, Jimmy, whose parents will pay $40,000 without batting an eye. Jimmy is actually making Billy's scholarship possible.

What's happened over the last 20 years isn't so much that tuition has increased, but that prices have become more discriminatory based on your parents' income. Given the rise in income inequality, that's an awesome thing. It equalizes opportunity in an economy in which education is more important than ever.

If actual tuition hasn't gone up that much, why has student debt ballooned from $600 billion in 2006 to $1.2 trillion today? Mostly because of rip-off for-profit schools, and because more students are attending college overall. Per-borrower student debt amounts for public-school students rose less than 1% a year from 2000 to 2010, adjusted for inflation.

The more we repeat misleading statistics about how expensive college is, the more young people will turn away from it. There are easy and affordable ways to get a great education.

We should stop saying that how the government measures inflation is a conspiracy to fool you. I have no interest in defending governments, but some of the criticisms waged against how we measure inflation are just wrong.

The U.S. Bureau of Labor Statistics measures inflation by tracking the change in price of a bunch of products. This sounds straightforward, but it's actually really complicated.

Eight years ago, a cell phone cost maybe $100. Today, the price tag is $500 and up. But that's because old phones could make calls, but do little else.Today's smartphones are miniature computers. It's wrong to say the price of cell phones has surged fivefold, because the quality of those phones is night and day. 

The BLS fixes this problem with what it calls "hedonic adjustments," tweaking the price of some products to reflect improved quality. In this case, it would adjust the price of smartphones down, making inflation look tamer.

Hedonic adjustments are fodder for pundits to claim the government is fiddling with the numbers to make reported inflation appear lower than it really is. Complaints spiked over the last 15 years as more adjustments for technology products were introduced. (See here, here, and here.) 

But on net, these adjustments don't change reported inflation the way critics think they do.

Some products, such as computers and cell phones, improve in quality over time. Hedonic adjustments tweak their prices down. Other products, like rental housing, deteriorate over time. Hedonic adjustments push those prices up. Of all the new adjustments introduced since the late 1990s, the net effect has increased reported inflation. The BLS writes:

The hedonic quality adjustments introduced since 1998 have had an upward impact in five item categories and a downward impact in five. The overall impact of these newly introduced hedonic models has been quite modest and in an upward, not downward, direction. To be precise, the use of the models has increased the annual rate of change of the all-items CPI, but by only about 0.005 percent per year.

To reiterate: If we got rid of all the new hedonic adjustments people complain about, reported inflation today would be lower, not higher.

For the first time, everyone in the country has easy access to economic data. That's a great thing. When the quality of that data is unfairly criticized, people lose trust in something that is an indispensable public good.

We should stop exaggerating how much corporate taxes have declined. Corporations use all kinds of loopholes to lower their tax bills. But there's one popular way to show the decline of corporate taxes over time that isn't fair.

Measure corporate taxes as a percent of all federal government tax receipts, and you get this:


Source: Office of Management and Budget.

This chart is a popular way to show that corporations used to carry their fair share in this country, and now they're ducking out. I've used it in the past.

But I now realize how misleading it is.

The chart shows corporate taxes, which are very different from business taxes.

Corporate taxes are paid by corporations. But most businesses aren't corporations. They're LLCs, S-Corps, sole proprietorships, and so on. These businesses don't pay taxes themselves. Instead, profits are passed to the individual shareholders, who pay personal taxes on their share of profits.

Over the last half-century -- particularly the last 30 years – far more businesses have chosen to be LLCs and S-Corps than corporations. S-Corps didn't even exist until the 1950s. Before that, most businesses were taxed as corporations. By the late 1970s, 83% of all businesses were LLCs and S-Corps that passed income to their individual owners. Today, 95% are.

That shift in business structure explains a lot of why corporate taxes as a percentage of all taxes have plunged. It's not that businesses aren't paying their fair share, like they were in the past. It's that more business income is being taxed as individual income, which doesn't show up in this chart.

If all businesses were corporations, as they nearly were 60 years ago, corporate tax receipts would have been $187 billion higher than the $370 billion that was actually paid in 2007, according to the Congressional Budget Office.

Our tax system is a mess and needs a massive overhaul. But if a chart looks too shocking to be true, it probably is.

"People will generally accept facts as truth only if the facts agree with what they already believe," Andy Rooney once said. Take these as you wish.

Check back every Tuesday and Friday for Morgan Housel's columns. 

Contact Morgan Housel at The Motley Fool has a disclosure policy.

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