Now let's get back to our 15 hour per week student worker. We next look at the federal income tax, which is progressive. Currently (2007) this rate is zero for the first $3,400 per year in income (technically this is because there is an "exemption" for this income), and it's 10% for the next $7,826 of income. If you make less than $3,400, the federal government will still probably take federal income taxes out of your paycheck (This is called withholding.), but they will refund the money to you at tax time.
What is the rest of the federal income tax schedule? The next $24,026 is taxed at 15%. The $45,251 after that is taxed at 25%. Then, the next $83,751 is taxed at 28%. Now we're getting into some very high incomes. The next $188,751 is taxed at 33%, and finally, any income after that is taxed at the top federal income tax rate of 35%. There are, however, income tax deductions and credits which can lower your tax bill substantially, but many people get none of these.
Next, there are state income taxes. Arizona follows the federal government in not taxing the first $3,400 in income. The next $10,000, though, is taxed at 2.73%. The $15,000 after that is taxed at 3.04%, the next $25,000 at 3.55%, the next $100,000 at 4.48%, and any income after that is taxed at 4.79%. There are also deductions and credits for state income taxes which can lower your tax bill substantially, but again many people get none of these.
State income taxes vary substantially from state to state. Some states have no state income tax at all, but remember, schools, police protection, roads, parks, universities, etc. are not free. They have to be paid for somehow. States with no income taxes may have higher property and sales taxes (or like Texas, they may have a lot of oil revenue which substitutes for income taxes). They may also simply have poorer schools, police protection, roads, parks, universities, etc. Mississippi and Alabama have some of the lowest overall taxes in the country, but also some of the poorest schools and infrastructure. You don't see a lot of wealthy individuals and families moving there from expensive high tax areas in California and New York to save on taxes. There's clearly a trade-off. So when you decide where to live, it's important to look at more than just how low the local taxes are.
Now, back to our example of a student working 15 hours per week to make $3,600 per school year in gross income, in order to take out less in federal student loans. Using what we learned earlier:
His FICA tax will be $3,600 x 7.65% = $3,600 x .0765 = $275.40.
For federal income taxes, the rate is zero on his first $3,400 in income. On the other $200 of his income, the tax rate is 10%; 10% of $200 is $20. So the student will pay $20 in federal income taxes.
For state income taxes, again, the first $3,400 is exempt, so he will only pay taxes on the next $200. The rate on that is 2.73%. $200 x 2.73% = $200 x .0273 = $5.46.
So, with an income of just $3,600, the student's total tax bill is very low, just:
$275.40 + $20 + $5.46 = $300.86
Typically, more than this will actually be taken out of the students paychecks, but then the excess will be refunded at tax time. The total net amount paid in taxes will end up being just $300.86. And $300.86 divided by $3,600 is .0836, or 8.36%. So the student is paying 8.36% of his income in total taxes. If he works during the summer too, he will be pushed into a higher tax zone, and this percentage will rise.
Looking just at this $3,600, subtracting $300.86 in taxes leaves $3,299.14 in take home pay.
So, if the student works 15 hours per week he can take out about $3,300 less in safe federal student loan debt per year. That's $13,200 less in total debt if it takes 4 years to graduate.
Is it worth it?
Again, it depends on the student, but if the student has reasonably good self discipline, then it probably is not worth it. $13,200 is not a difficult amount of debt for a typical college graduate to pay, if it's safe, reasonably low interest debt. And fully federal student loans are very safe and low interest debt. The interest rate, in fact, is actually zero while in school (for the subsidized type). There are hardship deferments if things go wrong, and there's always the option of an income contingent payment plan which limits payments to no more than 15% of disposable income.
With regard to the benefit of taking out this extra debt, being able to study an extra 15 hours per week can greatly improve learning, grades, and the odds of graduating. That is well worth an extra $13,200 in very safe low interest debt. For most students an extra 15 hours every week of studying will make an enormous difference. Remember, as I noted in my Investment Strategy article, according to the National Center for Education statistics at the U.S. Department of Education, only 29.2% of the 1997 entering class at the University of Arizona graduated four years later. Only 49.7% graduated after five years, and only 54.7% graduated after six years. And these numbers are not unusual for public universities. Studies have shown that over the last generation college graduation rates have fallen substantially, and an important part of the reason is that most students a generation ago (and especially two generations ago) did not work at all while going to college.
So, given how many students don't graduate from college, this risk is very real for most students. Thus, if you have the self discipline to put most or all of the 15 hours per week you would save from not working into studying, then this is well worth the cost of accumulating about $13,000 extra in very safe federal student loan debt over the course of your college career.
In addition, your grades will be higher, your learning will be greater, and you may graduate earlier. This will, on average, mean better jobs and career success, which will probably make you much more additional money over the course of your career than the $13,000 cost.
Note that studying more is not the only productive way to put the extra 15 hours per week to use. Many students don't get enough sleep. While many people think of sleep as optional, or lazy, science says otherwise. It is well established that not getting enough sleep can substantially diminish mental performance as well as physical. It can also make you much more susceptible to illness, and can make your mood and attitude more negative. All of this can substantially hurt your academic performance. It's one thing to stay up late from time to time and get up relatively early the next day; it's another thing to do it most of the time.
For some students, saving 15 hours per week not working may be best spent by putting 7 of them towards getting an extra hour per night of sleep, and 8 towards studying. The proper amount of sleep varies from individual to individual, however. You have to experiment with different schedules and see how they work for you, but if you are feeling tired all the time, having trouble concentrating, etc., then you will probably benefit substantially from getting more sleep.