Does Federal Aid Drive College Tuition? the "Greedy Colleges" Thesis Conflicts with How Nonprofit Universities Decide on Admissions and Pricing

By Archibald, Robert B.; Feldman, David H. | Regulation, Summer 2016 | Go to article overview

Does Federal Aid Drive College Tuition? the "Greedy Colleges" Thesis Conflicts with How Nonprofit Universities Decide on Admissions and Pricing


Archibald, Robert B., Feldman, David H., Regulation


Does an increase in the generosity of federal financial aid make college more affordable, or does it simply encourage colleges to raise tuition? In a Feb. 19, 1987 New York Times op-ed titled "Our Greedy Colleges," former federal secretary of education William Bennett made a strong case for the latter when he stated, "If anything, increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that federal loan subsidies would cushion the increase." This seemingly simple claim has spawned a long, often heated, and highly politicized debate.

The "Bennett hypothesis" often is justified as simple economics. Federal aid is a subsidy. Increases in subsidies raise demand, and rising demand pushes up price. Yet the textbook model of a perfectly competitive market is a poor fit for the higher education industry as a whole, and it's quite inappropriate for understanding how tuition is determined at the nonprofit institutions that still dominate the higher education landscape. Colleges and universities are price setters, not price takers. Yale, Valparaiso, and Southeast Missouri State all "sell" education, but the services they offer are quite differentiated. And unlike most firms, nonprofit colleges and universities often turn away business. They care about who purchases their services.

We will present a simple enrollment management model of how nonprofit colleges jointly decide how to fill their classes and set tuition. Any vice president for enrollment will recognize this model as a close representation of how these decisions actually are made. This simple theoretical structure often is missing from popular discussions of how federal policy affects affordability, and from empirical tests of possible links between aid and tuition. The enrollment management model does not prove kind to the idea that federal aid causes tuition inflation at nonprofit institutions. On the other hand, there is good evidence for a Bennett effect at for-profit schools, whose behavior is better represented by the textbook model.

Although our theoretical framework finds no incentive for most colleges to adjust their tuition in response to changes in federal aid, institutions can "tax" away a part of the federal aid by reducing their own institutional aid. Schools can redirect those resources to other institutional uses. However, unless this tax rate implausibly exceeds 100%, students will still see lower net price tuition. The best evidence on the tax rate is that it is low overall, but higher at highly selective private institutions that are very generous with their own aid.

ENROLLMENT MANAGEMENT

All schools that are even minimally selective must have a way to produce the best possible incoming class while also hitting target levels of enrollment and revenue. The following simple model shows how this is done. In the short run we will assume the size of the institution is set. Its buildings, faculty, and staff determine that size. The school also knows how much revenue it needs in order to maintain its quality, and how much of that revenue it needs to extract from students in the form of tuition.

The process begins with the pool of applicants. All selective schools have some mechanism to rank potential students. For example, a school might employ a 10-point scale. Students rated 10 are the highest-quality applicants from the institution's perspective. Amherst's 10's and "Compass Point" State's 10's aren't the same group. Amherst's 10's will have ratified test scores and very impressive high school records. Nonetheless, for Compass Point State, its 10's will have the highest test scores and the best high school transcripts of its applicant pool. In addition, many of the 10's will bring something special to the incoming class: they may be accomplished athletes or musicians, or they may offer geographic, economic, or racial diversity.

All schools would love to fill the incoming class with 10's, but few can come even remotely close to hitting their revenue needs from that group alone. …

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