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The Agenda

NRO’s domestic-policy blog, by Reihan Salam.

The Case for Phasing-Out Tax-Based Aid for Higher Education



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In “Rebalancing Resources and Incentives in Federal Student Aid,” Stephen Burd, Kevin Carey, Jason Delisle, Rachel Fishman, Alex Holt, Amy Laitinen, and Clare McCann of the New America Foundation propose a number of broad reforms, including, among other things, the following:

(1) restructuring the Pell Grant program to encourage college completion and to discourage extended and prolonged enrollments, to give higher education institutions that graduate substantial numbers of students from low-income households a bonus to be used to reduce the net price for low-income students;

(2) restructuring the federal student loan program to discourage over-borrowing by students and parents, which in turn will limit the ability of higher education institutions to raise tuition without limit;

(3) and redirecting $180 billion in tuition tax breaks, tax-advantaged savings plans, and the student loan interest deduction to the Pell Grant program.

Elaine Maag of the Tax Policy Center has more on tax-based aid at TaxVox:

In 2012, the $34.2 billion in tax-based aid represented nearly half of all non-loan federal assistance and rivaled the $35.6 billion in Pell grants. But unlike Pell grants that assist low-income students, tax subsidies often benefit students who are already likely to attend college. The Tax Policy Center estimates that in 2013, a quarter of the aid from the AOTC and half of the aid from the tuition and fees deduction will go to students in families with incomes between $100,000 and $200,000 (figure 2). According to the National Center for Education Statistics, in 2010 barely half of students from low-income families enrolled in two- or four-year colleges immediately after completing high school. In contrast, two-thirds of kids from middle-income families and 82 percent of kids from households making $100,000 or more went straight to college.

Maag’s discussion of tax-based aid reminded me of Andrew Gillen’s essay on what he called “the Bennett Hypothesis 2.0.” Gillen describes the canonical Bennett Hypothesis as follows:

1. Individually, each college is trying to improve (the pursuit of excellence).

2. More revenue is very useful in the quest for improvement. 

3. An increase in the generosity of financial aid gives colleges the option of acquiring more revenue by raising tuition to capture some of the aid. 

4. Most colleges will succumb to the temptation to raise tuition. 

a. Some colleges will exploit (3) immediately to help them accomplish (1).

b. To keep from falling behind the colleges in (4a), even colleges that did not exploit (3) initially are pressured to do so in the future. 

5. Thus, an increase in financial aid leads to higher tuition (the Bennett Hypothesis).

As Gillen observes, the scholarly evidence for the Bennett Hypothesis is mixed at best — yet he proposes three refinements, which I’ve noted alongside his lessons for policymakers:

1. All Aid is Not Created Equal

For policy makers, the key point is that financial aid that is restricted to low income students is much less likely to be captured by colleges, and will therefore be more likely to succeed in making college more affordable and therefore accessible (for low income students). In contrast, universally available programs are more likely to simply fuel tuition increases and therefore more likely to fail to make college more affordable. 

2. Selectivity, Tuition Caps, and Price Discrimination are Important

For policymakers, the first lesson is that capping tuition at public universities will encourage those universities to become more selective. This may be a good thing in some respects, but it does have drawbacks as well. The second lesson for policymakers concerns private universities. Price discrimination allows these colleges to raise tuition in response to aid at an individual level (this is just the Bennett Hypothesis at an individual level). But in order for colleges to price discriminate, they must know each student’s ability to pay. This means that providing colleges with students’ financial background will lead to more aid being captured. Bizarrely, the government currently provides colleges with this information, thus encouraging and facilitating price discrimination. Ending the counterproductive practice of providing colleges with information on the financial background of students and parents would curtail price discrimination, which would increase the effectiveness of aid in improving college affordability.

3. Don’t Ignore the Dynamic Story

[A]s college D spends more money, college E needs to spend more to avoid falling behind. If it wants to attract the best professors, it needs to increase pay, lower teaching loads, and build state of the art labs when college D does. And if it wants to recruit good students, it has to offer the same amenities that college D does. Thus, the same things that lead to higher future costs at college D lead to higher future costs at college E.

Given this landscape, Gillen — in the same spirit as the New America report — offers an alternative approach:

Because the nature of competition in higher education is the driving force behind these dysfunctional results, the clearest way to escape Bennett Hypothesis 2.0 is to change the nature of competition. Colleges compete in a zero-sum game based on prestige because they cannot compete based on value, and they cannot compete based on value because measures of both quality and price (net tuition) are obscured. If information on those two were available, the pursuit of excellence would be replaced by the pursuit of value, Bowen’s Rule would break down, and Bennett Hypothesis 2.0 would no longer be a concern.

Progress is being made in making pricing information available (colleges are now required to publish net price calculators), but there is no progress regarding quality. A good start would be to publicize employment outcomes, value-added pass rates on certification exams, etc. Until information on such outputs and outcomes is available, we will be stuck in a world where competition is based on prestige, which in turn means we will continue to suffer from Bowen’s Rule and Bennett Hypothesis 2.0.

Gillen also notes that there is another way out of the Bennett Hypothesis 2.0 trap, i.e., restricting aid only to the very poorest. This is part of the impetus for phasing out tax-based aid. 



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