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Posted at 04:00 AM ET, 05/18/2012

Why college tuitions are rising: A contrarian view

This was written by Gary C. Fethke, professor and former dean of the Henry B. Tippie College of Business at the University of Iowa, and Andrew J. Policano, dean of the Paul Merage School of Business at the University of California, Irvine. Their new book, “Public No More: A New Path to Excellence for America’s Public Universities,” will be published this month by Stanford University Press.

By Gary C. Fethke and Andrew J. Policano

The “Path to Prosperity” report issued by House Budget Committee Chairman Rep. Paul Ryan calls for limiting the growth of financial aid to college students. The report claims that “increases in Pell Grants appear to be matched nearly one for one by increases in tuition at private universities.” The assertion that increased aid increases tuition, the “Bennett Hypothesis,” has been endorsed by President Obama (in a speech made last January at the University of Michigan). Also, Mark Zandi, chief economist at Moody’s Analytics, argues that government loans and subsidies are not cost-effective for taxpayers because “universities and college just raise their tuition.”

The Ryan Report refers to a 2007 paper in the Economics of Education Review, in which the authors (Larry Singell and Joe Stone) in fact conclude: “Based on a panel of 71 universities from 1983 to 1996, we find little evidence of the Bennett hypothesis among either public or lower-ranked private universities.” Their study does find an effect on the tuition of non-targeted students at top-ranked private universities.

Our conjecture for this result is that Pell Grants, by raising demand for some, put upward pressure on all costs in these institutions. Specifically, if elite private universities are capacity constrained, an increase in demand will elicit a rise in tuition. Since over 80 percent of all college students attend public and for-profit universities, where there is no general evidence of the Bennett hypothesis, should public policy be directed by a result attributed to a small percentage of the college population?

Published tuitions depend on demand, cost, and state-subsidy conditions. Net tuition is lower than published tuition by federal grants and loans, and private scholarship support. For 2011, the College Board reported that published tuition and fees for public four-year institutions averaged $8,240, while net tuition and fees averaged $2,490; so tuition discounting is important. Enrollment decisions are based on net tuition.

Does the Bennett Hypothesis make conceptual sense? Actually, it doesn’t.

No apparent tuition-setting approach leads to the conclusion that net tuition should be higher for the targeted group in response to a higher Pell Grant; in fact, net tuition should be lower if the intent is to increase net revenue. Indeed, when public universities face a policy-imposed break-even constraint, changes in net tuition should be matched one-for-one by offsetting changes in the per student Pell grant.

Why, then, are tuitions rising? The Path to Prosperity report also raises concerns about the cost of higher education, stating that “College costs have risen at twice the rate of inflation for about thirty years, but this year fees soared 8.3 percent -- more than double the inflation rate -- as federal subsidies have increased at a historic pace.” President Obama asserts repeatedly: “We can’t just keep subsidizing skyrocketing tuition.”

There appear to be at least two misperceptions. The first may involve confusion between the cost of education and tuition, and the second concerns the actual trend in total government support per student. Net tuition is the price students actually, which is declining on average, and cost is the expenditure incurred by universities. For each enrolled student, a university receives the sum of the subsidy (state and federal) and net tuition. These revenue sources allow the non-profit university to cover its expenditures. Costs per student are not increasing at extraordinary rates. The College Board reports that real instruction cost per student increased at slightly over one percent annually over the past decade.

The second misconception confuses totals with averages. With enrollment expanding, an increase in overall government support can still be associated with declining support per student. For well over a decade, especially following the Great Recession, the average of federal and state subsidies per student has decreased. Indeed, in many states, the total subsidy has decreased. Tuition revenue has become a more important revenue contributor, with students in the aggregate paying more and taxpayers paying less. What has been driving higher published tuitions is not higher per student cost of higher education, but rather who pays for it.

Somewhat paradoxically, as appropriations are cut, many legislators call for increased accountability and transparency. They assert that public universities are squandering taxpayer’s funds, for example, by spending egregious amounts on administrative and coaching salaries; they recommend that universities reduce expenditures and “eliminate waste” to stop tuition from increasing.

We agree there is the need for universities to improve operating efficiency and to examine all possible compensation excesses. However, there is also the need to recognize that demand patterns for public higher education have changed permanently. State legislators reveal by their budgetary decisions that public demand for higher education is permanently lower. This permanent decline in the level of public demand at the state level is the driving force behind the large increases in published tuition. The choice between supporting Medicaid or higher education seems to favor the former. Universities and legislators should accept this funding reality, tone down the blame game, and turn their attention to allocating resources to better align new demand patterns with rationalized program expenditures.

The major changes that need to take place are for public universities to become more: entrepreneurial, efficient in setting tuition, attentive to student preferences, and less dependent on taxpayer subsidies. Continued allocation of new tuition revenue to finance traditionally-subsidized programs that feature a limited willingness to pay by students, taxpayers and donors is unsustainable.

Nobody seeks to defer all judgment to market forces, but, rather, it is important to become focused on what programs are essential to providing a high-quality university education. As difficult as some adjustments will be, competing for better-informed and prepared students, respecting the social benefits of education, and providing responsive stewardship for declining levels of taxpayer support are good things to do.

Those public universities that follow the path toward becoming “public-no-more” can succeed. Those that do not change will face intense competitive pressure and may ultimately decline.

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