The conventional solution for America’s education problems, advocated by politicians on the right as much as those on the left, is to invest more resources in higher education. But that is exactly what we’ve been doing. At the end of the Clinton presidency, a time many look to with great nostalgia, the federal government provided the higher-education sector with $64 billion in grants, loans, and tax credits in inflation-adjusted 2010 dollars. As Kevin Carey, head of the think tank Education Sector, has observed, that number soared over the intervening decade to $169 billion. And over this same period, the total amount of outstanding student-loan debt doubled to $1 trillion.
So what exactly is happening to all of this money? Why isn’t a sharp increase in the amount we’re spending on higher education translating into higher college-completion rates? The discomfiting answer is that the higher-education industry is enriching itself at the expense of taxpayers and students. Students and recent graduates burdened by debt shouldn’t be calling for more public subsidies, the banner taken up by many in the Occupy movement. Rather, they should take aim at the higher-education cartel that has been extracting ever more resources without offering an improved product.
Higher education has become a very profitable industry. Since most colleges are legally organized as non-profits, they do not earn profits in the traditional sense. But a kind of profit occurs whenever a non-profit derives more revenue from providing a service than it costs to provide. Universities do not pay out these profits in the form of dividends to shareholders; they spend them.
For most colleges, the revenue derived from providing undergraduate education exceeds the actual cost of providing that education. The excess is spent in two ways: economic rents and subsidies for other missions. Economic rents are payments made to college insiders that do not increase the college’s output. Excess compensation (e.g., when the president of a small college makes over $1 million) and featherbedding (e.g., a 10:1 student-to-faculty ratio) are economic rents. Subsidies for other missions include the revenue from undergraduate tuition that is spent on graduate education and research. Unlike economic rents, this spending does increase colleges’ output and is not bad per se. Yet it is spending beyond what is necessary to provide an undergraduate student with a high-quality education.
The free-spending nature of non-profit colleges is well known. As longtime Harvard president Derek Bok once quipped, “Universities share one characteristic with compulsive gamblers and exiled royalty: There is never enough money to satisfy their desires.”
Thirty years ago, Howard R. Bowen, an economist who served as president of three different colleges, proposed what is known in education circles as Bowen’s Law. It can be summarized as “Colleges raise all the money they can, and spend all the money they can raise.” But don’t colleges try their best to keep costs low in order to keep tuition down? No, it turns out that they don’t. As Bowen pointed out: “The question of what ought higher education to cost — what is the minimal amount needed to provide services of acceptable quality — does not enter the process except as it is imposed from the outside.” And those who provide the money, the legislators and students and families who pay tuition, have failed to check the tendency to overspend.
Robert E. Martin, an economics professor with substantial experience as a faculty member at both a large state research university and a small liberal-arts college, recently expanded on Bowen’s Law. He concluded that “because costs in higher education are capped only by total revenues, there is no incentive to minimize costs.” So when colleges are able to secure new revenues, costs increase commensurately. And these higher costs, in turn, are used “as justification for more revenue.” Suffice it to say, this dynamic wouldn’t be tolerated in many other industries. Bowen proposed his law over 30 years ago. In the time since, colleges have spent money and raised tuition as rapidly as the market and legislators have been able to bear. They have been so successful at raising prices that their basic financial model has changed. Non-profit colleges, whether private or government-owned, were originally designed to provide an education to students funded by a mix of commercial and donated financing. The commercial financing came in the form of tuition paid by students. The donations came in the form of charitable giving and state subsidies, and benefited students by reducing tuition. This is how most non-profit colleges were funded until the 1980s.
Since then, the amount of donated financing has increased substantially. In 1980, states were the primary donors to higher education through the subsidy they provided to state-owned colleges. They have continued to generously fund higher education. While in some years there have been cuts because of downturns in state tax revenues, historically the subsidy has gone back up as the state’s financial position has improved. In fact, between 1987 and 2009, per capita state spending on higher education increased by 31 percent after accounting for inflation.
At the same time, private donations have gone up, and the federal government radically increased financing for higher education. From 2000 to 2010, annual student lending went from $42 billion to $96 billion, and Pell grants increased from $9 billion to $28 billion. Congress also created federal tax deductions and credits. For example, in 2010, a married couple with an income under $160,000 received a $2,500 credit for their child’s college tuition. Total federal tax benefits for higher education in 2009 totaled $18.2 billion.