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“Our greedy colleges”

Why financial aid might make college more expensive

College is expensive. Financial aid is supposed to help. But what if it doesn't? What if the fact that students can get help from the federal government to pay for college just leads colleges to charge more?

recent paper from the Federal Reserve Bank of New York finds that for every extra dollar a college gets in Pell Grants, the school charges 40 cents more in tuition. For every extra dollar in subsidized student loans, tuition goes up 65 cents. The effects were much more pronounced at private colleges.

The new research adds to a pile of sometimes conflicting evidence about how much effect financial aid has on college tuition. Over the past 20 years, studies have shown that increases in some types of aid correspond with some colleges increasing their prices. But there's no consensus about what types of aid, or which colleges are most affected.

The bottom line

What we know:

Some studies have found that some colleges raise their prices after increases in federal financial aid, although others conflict with this idea. Recent studies have generally been more likely to find a link. They also find that private colleges are more likely to raise tuition when there is more federal financial aid.

What we don't know:

Whether federal financial aid actually causes tuition to increase.

What this means:

If financial aid does lead to higher tuition prices, the programs should be redesigned to avoid these unintended consequences. But the link isn’t firmly established enough to say for sure that this is necessary.

Has financial aid really enabled "greedy colleges"?

Since 1984, the published prices of private four-year colleges have more than doubled. At public four-year colleges, they've more than quadrupled.

There are many contributing factors, including that colleges are spending more on administration and states are spending less per student on higher education.

But one theory is that increases in federal financial aid have contributed to the trend by allowing colleges to raise prices and take in more tuition without worrying that students won't be able to afford it.

Most federal help to pay for college is a voucher system. Instead of sending money directly to colleges, the Education Department gives it out to students in the form of grants and loans, and students can use that money wherever they choose. The maximum loan a student can take out is determined by the school's "cost of attendance," a figure that colleges come up with themselves.

So it's possible for colleges to change their prices in response to federal financial aid — charging more because they know students will have some money guaranteed to pay it. And for nearly 30 years, some have argued that they do, and that's why college has gotten so much more expensive. The idea started with William Bennett, then the education secretary under Ronald Reagan.

In a New York Times op-ed in February 1987 with the headline "Our Greedy Colleges," Bennett argued that "increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that Federal loan subsidies would help cushion the increase. ... Federal student aid policies do not cause college price inflation, but there is little doubt that they help make it possible."

What the New York Fed study found

Man stacking coins up in growing piles

The paper looked at whether colleges take advantage of increased government spending. (Shutterstock)

The new paper by the New York Fed's researchers — David Lucca, Taylor Nadauld, and Karen Shen — is the latest contribution to this debate. The researchers studied how college tuition changed between 2001 and 2011. During that time, Congress increased the maximum Pell Grants, and students could also borrow more in federal loans than they had been before.

The researchers found that increases in Pell Grants and subsidized student loans corresponded with an increase in tuition prices.

Colleges most likely to raise their listed tuition prices in response to changes in federal loan policy were private colleges with tuition of at least $22,000 that admitted 74 percent of applicants. Most of their students were from relatively well-off families; the financial aid office expected them to spend at least $18,000 on their students' education.

In other words, the colleges most likely to respond to changes in Pell Grants by raising their tuition were private and expensive, but not particularly selective. Their budgets probably depend more on students' tuition than on returns from a massive endowment.

That's where a caveat comes in. The New York Fed study looked at sticker price — what colleges say they charge — and not net price, which is what students actually pay after financial aid. Net price takes federal grants into effect, but it also takes into account grants and scholarships from the colleges themselves.

And far more students at private colleges get financial aid from their college than from the government: 67 percent, according to the College Board. So it's possible that while colleges were increasing their prices, they were also increasing their discounts to make students feel like they were getting a good deal. Colleges' discount rate increased quite a bit during the time period the New York Fed researchers studied.

"They might have found different results if they used net price," said Donald Heller, dean of the college of education at Michigan State University, who has studied the issue.

But this has been studied extensively — and not all researchers have found a link

Key studies:

1991: "Keeping College Affordable: Government and Educational Opportunity," Michael McPherson and Morton Schapiro. The researchers looked at data on colleges' finances and financial aid between 1979 and 1986. They found no evidence that private colleges raised tuition when federal student aid increased, and private colleges also increased their own financial aid spending by $20 for every $100 in federal increases. Public colleges, though, raised tuition by about $50 for every $100 in additional aid.

2001: National Center for Education Statistics "Study of College Costs and Prices, 1988-89 to 1997-98." This study found no association between increases in federal grants or loans and changes in tuition at public or nonprofit private colleges.

2003: "For Whom the Pell Tolls," Larry D. Singell Jr. and Joe A. Stone. This study found the most selective private universities raised tuition by a much greater factor than Pell Grants increased. Public universities did not change their tuition policies.

2003: "Resident and Nonresident Tuition and Enrollment at Flagship State Universities," Michael J. Rizzo and Ronald G. Ehrenberg. This study found no relationship between federal financial aid and public universities' prices for in-state or out-of-state students.

2012: "Does Federal Student Aid Raise Tuition? New Evidence on For-Profit Colleges," Stephanie Riegg Cellini and Claudia Goldin. For-profit colleges whose students are eligible to get federal financial aid charge more than similar for-profit colleges whose students are not. The difference in prices is about the same size as the amount of financial aid students are receiving.

2014: "The Road to Pell Is Paved With Good Intentions: The Economic Incidence of Federal Student Grant Aid," Lesley J. Turner. Colleges respond to increases in Pell Grants by changing their own financial aid policies, keeping about 12 percent of the grants themselves.

2015: New York Fed, "Credit Supply and the Rise in College Tuition: Evidence From the Expansion in Federal Student Aid Programs," David O. Lucca, Taylor Nadauld, Karen Shen. This study found that increases in federal grants and subsidized loans led to higher tuition for students, with the strongest link for subsidized loans at expensive but not particularly selective private colleges.

The relationships that researchers have found between federal financial aid and tuition are either complex or downright contradictory. No one has found a direct relationship between increases in grant spending and increased tuition at all types of colleges. And researchers, including those behind this new study, have generally found only evidence of correlation, not causation.

In 1991, Michael McPherson and Morton Schapiro, two economists of higher education, studied the issue and suggested that increases in federal grants and loan limits could have led to tuition increases at public colleges, but not at private colleges. But they also argued that because public colleges had raised tuition so much in the 1980s, they couldn't continue to do so.

McPherson and Schapiro saw their work as disproving Bennett's idea: "The fact that federal aid dollars are keyed to student financial need, which rises with tuition, makes it appear that colleges should be able to capture more federal aid by raising prices," they wrote. "However, the impression dissolves on closer inspection."

In 2003, Michael Rizzo and Ronald Ehrenberg found no relationship between public universities' tuition and increases in federal financial aid. The same year, two economists from the University of Oregon, Larry D. Singell Jr. and Joe A. Stone, found the opposite result. Using data from 71 universities between 1983 and 1996, they found that public universities increased out-of-state tuition, and the most prestigious private universities increased their tuition, when federal financial aid increased. But those private universities tend to have very few students receiving Pell Grants in the first place, so it's possible there was another explanation for their pricing changes.

In 2014, Lesley J. Turner, an economist at the University of Maryland, found that colleges end up keeping about 12 percent of Pell Grants because they change their policies for their own grants and scholarships to make them less generous. The effect was most pronounced at selective nonprofit colleges, and barely occurred at all at the public colleges that most students attend.

For-profit colleges, which get about 78 percent of their revenue from the federal government's student aid programs, seem the most likely to increase their tuition in response to federal financial aid changes. In 2012, Stephanie Riegg Cellini of George Washington University and Claudia Goldin of Harvard found that for-profit colleges whose students could get federal financial aid charged more than similar colleges whose students could not. The difference in the prices was about equal to the amount of federal aid students at for-profits received.

Why this argument is so important for the future of financial aid

Given these results, some have argued that the Bennett Hypothesis is broadly true but not nuanced enough — it doesn't account for the different effects of different types of financial aid. Others reject it entirely. And that's in part because of the political implications for federal aid for college.

Those implications aren't necessarily drastic. Andrew Gillen, a program officer at the conservative Charles Koch Foundation who broadly supports the Bennett Hypothesis, has proposed basing the formula for awarding financial aid on median college costs at various types of colleges, rather than on the specific cost of attendance at any given college. "As soon as you break that tie between a school raising their tuition and their students then qualifying for more aid, you really do defeat the Bennett Hypothesis once and for all," he said.

But others go much further. When the Bennett Hypothesis comes up in policymaking, the argument usually goes like this: If financial aid leads colleges to increase their prices, then financial aid is a waste of money and the federal government should spend less on it. High tuition prices aren't a problem the government can solve — they're the government's fault.

"Until we radically rethink and downsize federal student aid programs, the burden of a college education is not going to start falling substantially," Richard Vedder, who directs the Center for College Affordability and Productivity at Ohio University and is a leading proponent of this view, wrote in Forbes in response to the New York Fed study.

The possible consequences are what make the Bennett Hypothesis so controversial. And it's why its opponents argue against it so strongly.

"Nobody has argued that the availability of car loans has pushed up the price of cars," said Heller, of Michigan State. "And that's the argument they want to make about federal loans and the price of college."

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