The social merits of private education (2 of several)
Reviewing the basic economics of education: merit goods, externalities, and the core recommendation to subsidise not tax
The numbers don’t add up on Labour’s VAT policy. It won’t raise anything like £1.6bn and it could have a net cost to the Exchequer if significant numbers of families switch to have their education for free paid for out of taxation. Other posts here, here, here , here, here, here and here have explored the fiscal concerns.
Aside from those fiscal consequences, this series looks at the actual merits of education as I previewed here. The point to be made, repeatedly, is that private schools are good for society as well as for their customers, and that the social benefit is about more than the savings to the Exchequer (although that’s very important). This particular post introduces education economics at the basic level. TL; DR version
Education is a merit good not a public good; education is good for society and the market would tend to under-deliver
We normally recommend supporting education via subsidies or actual tax-breaks, particularly where private education relieves the burden of state provision
Taxing any education is an odd place to start; far from being (as advocates imply) commonsense rationalisation, taxing private education is a radical and antisocial policy that would make the UK an international oddball
If you took A-level economics you’ll recognise much of this - I’ll have some more original things to say later on.
Education is not a Public Good
Any time anyone mentions to you that “Education is a right, not a privilege” or that “Education is a public good”, you should groan with exasperation. After reading this section, you’ll be able to respond that a Public Good has a very specific definition, and that education doesn’t fit in it. A Public Good (or service) is
non-excludable which means if it’s provided, you can’t stop anyone receiving it even if you’d like to. This means it’s very hard to charge any price at all for it….because the customer might prefer to “free-ride” by using it without paying
non-rivalrous which means that you receive the full benefit regardless of how many other people are there to share it with you
Common examples are national defence and street-lighting. The army can’t refuse to defend anyone; everyone receives the same level of defence whether or not they pay and regardless how many people there are. Because of those two conditions, market forces are typically considered unable to provide Public Goods. If you want Public Goods you either need government to step in, so you can charge people taxes by virtue of their mere presence, and be willing to expel them or lock them up if they refuse to pay, or you need voluntary contributions.
It’s easy to see that education isn’t a Public Good. Children can be excluded from a school; increasing the number of children in a school or classroom beyond some ideal number dilutes the benefit received by each child.
Education is not a Public Good. The market can provide education. We know this because it is excludable and rivalrous. We also know this because there are, and have been for centuries, fee-paying schools.
Education is a Merit Good
A merit good is a little more complicated. A merit good can be provided by the market, however there social benefits when somebody receives education. Because the private customer buys education based only on the benefit to themselves, and is assumed not to value the benefit to others, they will buy some education, but not enough; or alternatively some, but not enough, customers will buy education.
The social benefits of education are called externalities - they are consequences that are external to (ignored by) the people making decisions in the market. They include:
Productivity. If qualified, employable young people join the workforce, they will earn money (benefit to themselves) and deliver value to customers, employers and employees (benefit to others). The more productive they become, the greater the social benefit.
Taxation and public sector. Increasing productivity grows the economy which in turn provides a bigger tax base. Also, the more “progressive” the tax system (as in the UK, where higher earners pay much higher rates of tax as well as higher amounts), the greater the social benefit arising from highly-educated/highly-productive people specifically
Citizenship. If young people are helped to become thoughtful adults they bring benefit to others in terms of democratic participation (voting and debating); legitimate economic participation (avoidance of crime) and helping others (charitable activity)
Public spending. In a society where education is provided
freeat the expense of the taxpayer, then every child that is privately educated represents a saving to the state system.
Figure 1 - underprovision of education in a market economy
The chart shows the market for education.
The red line "Dp” stands for demand - private. At higher prices p (vertical axis), customers will buy a smaller quantity q of education; at lower prices, customers buy more education (or, more customers buy the same quantity of education). Dp is derived from the amount of private benefit perceived by customers.
The blue line S stands for supply and it slopes the opposite way. At higher prices, schools provide more education (or more schools open up). S is derived from the cost of education
Equilibrium occurs where Dp and S intersect. The market will deliver quantity q1 of education at price p1.
But that has ignored the social demand “Ds”, which is derived from the private plus social/externality benefit of education. The private customer only took into account his/her education benefit; they didn’t take into account the benefit to others. Society would be better off if customers received quantity q2 of education at price p2.
What to do
One typical response to this situation is to subsidise; to provide taxpayers’ money that is added to the price paid by the customer, which moves the effective demand curve out to match Ds.
Figure 2 - merit good optimally provided with a subsidy
Here, the addition of a subsidy G takes us up from Dp (the private demand curve) to Ds (society’s demand curve).
Customers now receive more education (q2 instead of q1), which is socially-optimal; they only have to pay p3 instead of p1 or p2. Customers are delighted.
Society is also happy as everyone benefits from more productive people, paying more taxes, being better citizens and relieving pressure on state education.
It’s irrelevant if the subsidy is granted to customers or suppliers; the chart can be re-drawn with a rightward shift of the supply curve S and the effect is exactly the same
The subsidy G costs money which has to come from somewhere, however for indicative purposes we can assume the cost to taxpayers is already reflected in the social demand curve Ds.
What not to do
It might already be obvious that a tax on customers (such as a VAT) instead of a subsidy would have the opposite effect, moving demand downwards. But here’s the chart in case it’s helpful:
Figure 3: merit good with VAT applied
Here the intervention of Government to impose a value-added tax T causes demand to shift downwards from Dp (Demand-private) to Dt (Demand-taxed).
Society would like q2 of education delivered at price p2, reflecting social benefits. That’s terrific for the customers who only pay p3, and better (in general) for everyone else, compared to the market outcome of q1 of education at price p1.
Unfortunately, the VAT means we only get q3 of education, while the customers now have to pay p2 (the cost of the education indicated by the supply curve, plus the value of the tax T).
Don’t believe me….
There’s a helpful reference here that supports what I’ve said in this post, and is the mainstream view most economists start from. And here is a slightly deeper overview of merit goods.
“A private school provides an external benefit because the workforce will be more educated in the future and it saves the cost of government education in a publically-funded school.”
Some commentators reject the mainstream view on this post; they don’t agree that (1) private schools offer net social benefit or that (2) the avoidance of state expense can be considered a social benefit. The former, which is at least interesting, is because they think inequality eclipses all other considerations. The latter, which is banal and silly, is because they believe that tax revenue and state schools come from the Tooth Fairy or something. Future posts will go into more detail and, I believe, offer some original perspectives.
Conclusion
Education is not a Public Good. If someone tells you it is, they are wrong.
Education is a Merit Good. Merit goods have social benefits which we call externalities. The social benefits of private education are many, and include the avoidance of government expenditure on state education.
A typical way to treat Merit Goods is via a subsidy. A tax is a step in the wrong direction.