Monday, January 04, 2010

PRIVATE INVESTMENT IN COLLEGE EDUCATION FOR THE DEPRIVED

(An alternative approach using the “income tax” model)

In the paper “Educating India’s poorest: A radical plan to attract Private Sector investment”(1), I make a case for attracting private investment in the education of India’s poorest and most vulnerable children in return for the federal government agreeing to give up the entire income tax payments by the beneficiaries over their lifetime.

I believe that based on this core idea, a workable plan can be devised to enable private investment in the college education of talented but (economically) disadvantaged American students. Here are my thoughts about how this can be done.

At the outset, a word about the differences in the two contexts. For private investors putting money into educating India’s poorest children, the timeframes and the risks involved are huge, with a gap of fifteen years or so before the returns come through. Investors in America looking at paying for the college education of deprived but talented students do not run this kind of risk because they would step in only after the beneficiary has revealed ample evidence of his talent and capabilities. Moreover, the duration of a typical college degree programme—effectively, the period of wait before the returns come through—runs to only about four years. Consequently, there is little reason to go anywhere near to the extent of signing away the beneficiary’s entire income tax or extending the payout to his lifetime contributions.

Now, the two questions that come up are how much and how far — what percentage of the beneficiary’s income tax contributions is to be appropriated in favour of the benefactor and how long should such appropriations continue?

A useful model to consider is the production sharing agreements under which western oil companies operate in the oil exporting countries. The two relevant (and widely used) terms are “cost oil” and “profit oil”. Cost oil is defined as “a portion of produced oil that the operator applies on an annual basis to recover defined costs specified by a production sharing contract.” Profit oil is “the amount of production, after deducting cost oil production allocated to costs and expenses, which will be divided between the participating parties and the host government under the production sharing contract.” (2) In the initial years, the typical production sharing contract will have a much greater component of cost oil, implying that most of the revenue goes towards defraying the exploration and development costs incurred by the oil company. Once these costs are fully recovered, the much larger share of the “profit oil” now goes to the host government.

Applying this model to the issue at hand, the simplest plan would have the government passing on the entire income tax proceeds in the initial years to the benefactor until his “defined” costs are fully met. Thereafter, a minor share will be passed on for a limited, pre-defined period. (After all, having minimized the risks, the upside can be capped as well.)

While the simplicity is welcome, the disadvantage here is that the government ends up making a substantial sacrifice early on and this would make it a difficult sell. A sensible way forward would be to rework the model by taking the stand that what the government passes on to the benefactors can only be that component which can justifiably be attributed to their efforts or intervention. This would involve defining a certain minimum level of income tax—say the median income tax amount for individuals nationally—up to which no amounts will be passed on to the benefactor simply because no out-of-the-ordinary financial success is indicated. In other words, this defined “minimum” would be the amount of income tax the government could reasonably have expected from the beneficiary even without a college degree. Tax proceeds over this defined minimum would be passed on in full measure to the benefactor. However, how long this arrangement should hold would still have to be decided, keeping viability in mind.

At this point, the cost of the college education to the beneficiary would amount to almost nothing. This has the drawback that anything given away for free soon loses value in the hands of the recipient. To get over this, and to ensure that beneficiaries remain committed and motivated, it would be reasonable to put in place a requirement for a specified minimum share (say, 25 percent) of the total cost to be compulsorily borne by the beneficiary. This minimum share can be in the form of a “down payment” or a loan component with water-tight repayment obligations.

What I have outlined here is merely one example of how a realistic plan can be shaped around this core idea. Once there is more thinking along these lines, I am sure we can expect many more alternative plans and models. However, the underlying principle, I believe, should remain the same: higher the risk, greater the upside potential.

Finally, this is a point worth reiterating: The narrow focus on the future income tax payments by the beneficiaries has two advantages. It can easily be tracked at a centralised level. And, it provides a ready and quantifiable measure of the success attained by each individual beneficiary, which allows proportionate reward to the benefactors, without scope for subjective considerations. ◄►



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Endnotes

(1)Available as a working paper at http://mpra.ub.uni-muenchen.de/20462/

(2)http://www.glossary.oilfield.slb.com/search.cfm

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1 Comments:

At 12:16 pm , Anonymous Anonymous said...

Ranjan,

I just have a quick question for you but couldn't find an email so had to resort to this. I am a left wing political blogger. Please email me back at barbaraobrien@maacenter.org when you get a chance. Thanks.

Barbara

 

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