In the wizarding world, the UK’s most famous school—Hogwarts—is a state school that charges no tuition and is open to all capable of witchcraft. Despite its open-door policy, Hogwarts boasts an alumni list brimming with accomplished wizards and witches, many of whom have gone on to write the very textbooks used in the Harry Potter universe. This idealized portrayal of secondary education, however, stands in stark contrast to the reality of the UK’s non-selective state schools, where such consistent academic success is far rarer.
One piece of evidence is the record of Nobel Prizes won in the sciences (where I generously boost the state schools’ success rate by including Economics) since the fall of the Iron Curtain in 1989. During this period, 29 UK high school-educated individuals were awarded Nobel Prizes—the highest number in Europe. However, only 6 of these laureates attended non-selective state schools (including two distinguished Scottish institutions and one faith school). In contrast, 9 attended selective grammar schools, and a striking 14 were educated at independent, private schools. This data suggests that independent schools, despite serving only a small percentage of British students, play a disproportionately large role in producing scientific excellence. To appreciate the impact of private education, consider the more populous Germany, which has a very limited tradition of private schools, but a historically strong state-school system with a better contemporary PISA performance. In the period beginning in 1989, the country has produced only 18 Nobel laureates in the sciences.
Critics often venture that private schools perpetuate social segregation, catering to affluent families who wish to separate their children from those of lower-income parents. Whilst this critique reflects a broader societal concern, it does not fully account for the demand for private education. The consistently superior ‘A level’ results achieved by independent school students compared to their peers in selective state schools suggest that private education offers more than just an elite peer group—it provides a significant academic advantage that raises the country’s knowledge base, i.e., human capital.
In this post, I will not make a normative case for private schools. It may well be that the nurturing of top talent is overrated after all. Rather than celebrating the successes of the most gifted few who discover new treatments for unfortunate diseases or lay the foundation for future wealth-creating innovation, educational policy might be better focused on levelling the intolerable excellence that distinguishes some UK high schools from their peers. The recently introduced UK policy of charging VAT on independent school tuition is one such attempt. Beginning in January 2025, independent schools must apply a 20 % VAT charge to tuition paid by parents. This means that per 1£ of tuition charged, tuition earned by independent schools will amount to only 0.8£. Previously, such tuition went untaxed.
The UK government’s measure presents an intriguing policy experiment, one that echoes another significant tax increase in recent memory: the Trump administration’s 25% tariff on Chinese imports introduced in 2018. At the time, economists widely criticized the tariff, predicting that it would lead to higher input prices in the U.S. and welfare losses in both the U.S. and China. Short-term outcomes validated these concerns, with studies showing that the impact was even more severe in China. In a similar vein, one might expect that imposing VAT on independent school tuition will increase the cost of private education in the UK, reducing enrolment in equilibrium. The critical question is: by how much?
Let us consider a simple benchmark here where independent schools operate in a fully competitive market. In this case, VAT is fully passed on to parents, resulting in a tuition increase of 25% (1/0.8). Surely, not all parents will be willing or able to bear the increase in tuition. Consequently, some of the increased tax revenue will likely be redirected towards educating students in state schools who were previously enrolled in independent schools. In an extreme scenario, the tax revenue generated after the introduction of VAT might even fall short of the cost of educating former independent school students. Whether this occurs depends on the price elasticity of demand for private education. A back-of-the-envelope calculation can provide some insight. Let d denote the share of students who remain enrolled in independent schools and consider that private tuition is roughly double the amount spent per state school student. Thus, government net income increases if and only if 0.2 · 2 > 1 – d, which simplifies to d > 0.6. In practical terms, this means that if 40% or more of current independent school students switch to state schools in response to the government charging 20% VAT, the amount the government can spend on today’s state school students will decrease. Beware!
Is 40% an unrealistically high number? The Institute for Fiscal Studies suggests that it is. After crunching the numbers last year, they proposed that charging 20% VAT would increase effective VAT by only 15%, leading to an estimated 3–7% reduction in private school attendance. (At an effective VAT rate of 15%, fewer than 30% of private school students must switch to state schools for the government to at least break even: 0.15 ·2 > 1 – d.) The implied low price elasticity of demand—3–7% rather than 30%—seems reassuring and might encourage the government to proceed with the tax without fearing significant consequences. However, I have reservations about its accuracy. First, on empirical grounds: the estimate is based on the observation that since 2003, the real cost of private tuition has risen by 55%, while independent school enrolment has remained steady. The problem with extrapolating from past demand is that outside options are not easily comparable. An increase in tuition that widens the gap between private and state education quality (as was the case since 2003) reduces demand for private education by less than an increase in tuition that serves to narrow said gap (as the government now intends). In other words, the more successful the government is in improving state schools, the less realistic the IFS’s estimated 3–7% reduction in private school attendance becomes. Second, on theoretical grounds: consider a sole private school whose marginal costs are constant. It is a truism that a business cannot raise tuition by 1% and lose less than 1% of paying customers, as the IFS suggests. If this were the case, increasing tuition indefinitely would keep raising profits, which is absurd— even the wealthiest parents have finite resources only. As such, a price elasticity of demand below one as implied by a 3–7% reduction in private school attendance is implausible, at least in areas where competition among private schools is limited. It is in these areas where few independent schools exist to begin with that I anticipate a disproportionate number of closures due to the VAT levy.
In practice, the fully competitive benchmark is an unattained ideal. Casual observation suggests that independent schools live out the seeming paradox of enjoying some local market power without making a profit. Economists have a model for this: they call it monopolistic competition. More on this in another post. For now, let us take stock of what we have learnt:
- Nurturing Top Talent: There is suggestive evidence that private education in the UK is critical to nurturing top talent, as evidenced by the number of Nobel prizes awarded in the sciences. Countries like Germany, where education is predominantly provided by the state, do not achieve similar levels of success.
- Impact of Taxing Tuition Taxing tuition increases the cost of private education and reduces enrolment in independent schools, particularly in regions with fewer such schools. Caution is advised when extrapolating from past demand elasticity estimates, as the upcoming tuition increase is redistributive rather than quality-enhancing.
- Fiscal Implications: The fiscal case for taxing private education is not clear-cut: The additional demand for state-funded education may offset the revenue gained from taxing private schools, especially so if the government makes good on its promise of improving the quality of state schools.
Next time, I will sketch a model of monopolistic competition that reveals a curious link between price elasticity of demand and teacher-student ratios. Among other things, the model predicts that teacher-student ratios will rise, not fall, in response to the introduction of VAT. To read it here first, become a subscriber!
