Study Finds the Net Present Value of a Law Degree is Highly Positive

The hot legal paper of the moment is undoubtedly The Economic Value of a Law Dregree by Michael Simkovic and Frank McIntyre who are respectively a law professor and professor of finance.

Their data-driven conclusion (p. 49) flies directly in the face of recent conventional wisdom:

After controlling for observable differences, we find that a law degree is associated with approximately a 60 percent increase in expected median monthly earnings and a 50 percent increase in hourly wages, as well as reduced risk of unemployment or underemployment. We find earnings differences between men and women, and that these differences are due primarily to differences in hours worked. The law degree earnings premium is cyclical and recent years are within historic norms. Applying reasonable discount rates, we estimate the mean lifetime value of a law degree in 2012 dollars as of the start of law school to be approximately $1,000,000 before taxes, and $700,000 net of taxes. Median pre-tax lifetime values are approximately $600,000 (after taxes, $420,000). This suggests that, for most law school graduates, the value of a law degree typically exceeds its cost by a very large margin.

Some other key findings:

• [A] law degree increases both work hours and wages per hour, and most of the increase in earnings is due to increased earnings per hour. (p. 15)
• The mean annual earnings premium is approximately $53,300 …. starting salaries are not very good predictors of lifetime earnings. (16)
• Law degree holders’ annual earnings grow faster and peak later than bachelor degree holders (20).
• “Even at the 25th percentile, the earnings premium is large …. on a percentage basis, the earnings premium is similar for those at the median and 25th percentile, and considerably higher for those at the 75th percentile. In 2012 dollars, the annual earnings premium increases from $17,300 at the 25th percentile to $32,300 at the 50th percentile, to $62,200 at the 75th percentile.” (22-23)
• “The data does not suggest that law graduates were unaffected by the recession. Rather, earnings dropped for both law graduates and college graduates after the late 2000s recession, and law graduates maintained their relative advantage. It is this relative advantage—not absolute outcomes— that measures the value of the law degree. Our data suggest that law degree holders are not immune to economic downturns, but they have continued to fare better in the recent downturn than bachelor’s degree holders without advanced degrees. Moreover, long-term historic data remains a reasonable and appropriate data source to forecast future earnings premiums.” (32)
• “Rounding to the nearest $10,000, we find that the mean value of a law degree is $990,000, the median is $610,000, and the 25th and 75th percentiles are $350,000 and $1,100,000 respectively. The Internal Rate of Return at the median is 13 percent in real terms, or approximately 16 percent in nominal terms.” (41)
• “[E]ven at the 25th percentile, a law degree exceeds typical net-tuition costs by hundreds of thousands of dollars. At the mean and 75th percentiles, the difference is close to one million dollars. We therefore reject the claim that law degrees are priced above their value. Indeed, the value compared to net-tuition prices suggests that legal education is a competitive market in which surplus redounds to the benefit of student-consumers.” (41)
• There is a large gender difference at the high end: “Rounding to the nearest $10,000, the mean value of a law degree is $1,030,000 for men and $820,000 for women. The median values are $580,000 each for both men and women, although the premium is higher for women in earlier years and higher for men in later years. At the median, internal rates of return are 11.5 percent for men and 14.3 percent for women. Higher earnings for men at the high end of the distribution are likely due to longer hours and increased labor force participation.” (42)
• “Even at the 25th percentile of women, our estimate of the lifetime earnings premium of a law degree, $350,000, exceeds the typical cost of a law degree by a wide margin. That is, in spite of lower average lifetime earnings premiums for women compared to men, a law degree remains a good investment for most women who obtain a law degree.” (42)
• These are pre-tax dollars, but the after-tax story, at current tax rates, is similar: “the mean after tax value of a law degree is $720,000 for men and $570,000 for women. For low earners, such as those in the 25th percentile, values should be multiplied by 0.75. For very high earners, such as 75th percentile men, or for those anticipating higher tax rates in the future, values can be approximated with a 0.65 multiple.”
• The paper also presents data suggesting that the current law school ‘crisis’ is similar to previous cyclical downturns; they argue that the decision as to the value of law school should be based on relative earnings and unemployment to those with just a BA — to the extent everyone is doing badly now, law school graduates may still be doing well in relative terms.
• Key point: “Because we discount our estimated law degree value to the start of law school, interested parties can multiply annual net-tuition by three and compare the results to our estimates of after-tax value.” (43 n. 109)

I should note four assumptions in the calculations, set out at pages 39-40, that I think increase the claimed value of the law degree, although I don’t think any or all of them would change the bottom line enormously:

1. The authors assume that students graduate at 25 (thus giving them more years to realize the increased earnings).
2. They assume that law school costs $30,000 per year in tuition and expenses (which they say is consistent with ABA data on average net tuition after scholarships and grants in 2010-2011) — this allows them to say the opportunity cost per year is c. $55,000, which feels low to me although I admit I’m not clear on whether in light of #4 below this number includes living expenses; if it doesn’t it might be reasonable.
3. They assume law students earn an average of $24,000 in summer and term-time work during the 3 years of law school, which may be high.
4. They assume costs of living while in school are similar to costs of living while working full-time and that “any differences reflect consumption benefits, and therefore need not be accounted for separate from opportunity costs of lower in-school earnings.”

It seems like a careful job. I do want to stress that the numbers offered are present discounted value in current dollars and that they do NOT take account of the cost of tuition. Thus, to figure out how these numbers work for a prospective student, the student would need to compare the total of three years of law school tuition with a PDV of income estimate adjusted for these factors:

1. Age at graduation (the higher it is, the lower the PDV of the increase in the projected lifetime income stream)
2. Tuition (but not living expenses unless they are much higher than the alternative)
3. Lost salary during law school, after taxes (?), if much in excess of $25,000 per year
4. Gender, if you think existing patterns of work and/or discrimination will continue
5. Where you think you might be in the income distribution

Thus, to take a near-worst-case scenario assume you are a woman planning to graduate at age 25, who believe sex discrimination will continue, or that you may choose to drop out of the workforce, or take reduced hours, for a chunk of your career. Assume further you are risk-averse, and thus want to find out if a degree is a good value even if you earnings are at the 25th percentile in the class. [Note that the study ranked earnings by percentile, it did NOT estimate earnings by class rank, although we know there is some imperfect correlation. Thus the 25th percentile here is an income outcome not an educational outcome.] The present discounted value of your expected earnings is $427,500 (which is less than a similarly distributionally challenged male, who would have a PDV of $540,000). If your law school tuition and expenses (other than room and board you would pay anyway) are less than this in 2010 dollars, odds are you are making a smart bet in terms of net lifetime earnings. So if tuition is $160,000 total, and before law school you make $65,000 per year, you compare ($160,000 + (65,000 – 25,000)*3*[1-tax rate]) to the PDV post-tax value of the degree, which is $427,500. Because, say, $280,000 is less than $427,500, the law degree has a real positive net present value — over your expected life time, even if not in your first year out of law school. And of course the numbers are substantially better with less restrictive assumptions.

Note, however,that the analysis assumes you graduate. And it doesn’t attempt to take much account of the practical effects of an increased debt service burden when combined with undergraduate debt (except to note the historically low rate of student loan default for law grads as a group). Nor does it consider the effect that debt may have on your career choices or happiness. It could be that having less debt young might allow you to buy a house younger and thus be happier while having less money over all. But economists are not concerned with that sort of issue; this is a strictly financial calculation. Even so, it’s interesting work — and encouraging stuff for those of us engaged in the production of law graduates.

[Note: Latter part of next-to-last paragraph edited and expanded for clarity.]