The Corner

Economy & Business

Shock: Federal Student Aid Programs Lead to Increased Tuition Costs

Contain your surprise: Increases in federal student aid appear to lead to higher college tuition costs, according to a new study published by the Federal Reserve Bank of New York:

In this paper, we . . . identify the effect of increased loan supply on tuition following large policy changes between 2008 and 2010 in the maximum federal aid amounts available to undergraduate students. We find that institutions that were most exposed to these aid ahead of the policy changes experienced disproportionate tuition increases around these changes. We find a passthrough effect of Pell Grants and subsidized loans on sticker price tuition of about 55 and 65 cents on the dollar, respectively. For unsubsidized loans, the effect we estimate is about 30 percent in our baseline.

Translation: 55 to 65 cents of every dollar received via a Pell Grant or subsidized loan is swallowed up by increased tuition.

Here’s a handy graphic:

And, of course, these effects are not felt equally:

The summary statistics imply that the institutions most prone to raising tuition in response to the subsidized policy change are expensive four-year institutions, mostly private, with students from families with a high ability to pay. However, these institutions do not appear to be the most academically elite institutions, as measured by their middle-admittance rates.

That makes sense. Harvard has an endowment of $33 billion; it does not need to compete for government cash. But a private college like, say, Kenyon College, in Ohio — small (1,700 undergraduates), selective (24 percent acceptance rate), but not flush (endowment: $212 million) — might be tempted to raise tuition rates to capture federal aid dollars, knowing that many students will still be interested in attending a well-reputed liberal-arts school. Alternatively, Wayland Baptist University in Plainview, Texas, cannot depend on the well-to-do college-bound, so it is much less likely to raise tuition with federal aid policy changes, since that would have the effect of pricing out potential applicants.

The implication seems to be that it is neither the affluent nor the poor, but the middle class who bear the brunt of the passthrough effects. The authors conclude predictably:

From a welfare perspective, these estimates suggest that, while one would expect a student aid expansion to benefit its recipients, the subsidized loan expansion could have been to their detriment, on net, because of the sizable and offsetting tuition effect.

(They suggest that student aid programs “may help access to postsecondary education,” but that is a lackluster endorsement, to say the least.)

Writing at Inside Higher Ed in 2012, Andrew Gillen, research director for the Center for College Affordability and Productivity, noted that efforts since 1987 to confirm or repudiate the Bennett Hypothesis had returned mixed results. In the wake of this latest finding, his warning seems even more urgent:

Because competition among colleges is based on their relative standing, those colleges that exploit the opportunity to raise tuition when financial aid is increased will be able to improve relative to those that do not by hiring better professors, offering more aid to attract meritorious students, building state-of-the-art laboratories, etc. To avoid falling behind, even those colleges that initially resisted are forced to follow suit and raise tuition.

Federal student aid programs have done much good. I certainly cannot be too critical — I am indebted to them (literally) for helping me afford my own college education. But it was eminently predictable that these programs should have incentivized higher costs — and, ultimately, encouraged the bubble now threatening to burst.

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