Posted by: Discover Scholars | September 29, 2008

Why Government Aid Doesn’t Work

Last Monday, we quoted Richard Vedder’s claims that increases in government financial aid often lead to higher student tuition rather than increased affordability.

He neatly sums up his argument thusly:

For example, the idea of expanding Pell Grants to deal with affordability has problems: “all the new money gets absorbed.” Translation: colleges raise their tuition rates more when Pell Grants rise. (our emphasis)

This assertion is counterintuitive and the mechanism by which this occurs warrants further discussion.  David Friedman offers perhaps the clearest explanation, in his discussion of Barack Obama’s $4000 refundable tax credit that can be applied to tuition:

You are now getting $4000 a year from the government. … This part of Obama’s plan is represented as a way of helping people afford college, which it is. But it is also a massive subsidy to low end colleges. The credit only applies to tuition expenses, so if you send your child to a community college that only charges $2000/year, you only get a $2000/year tax credit. But once the proposal is implemented, there won’t be any colleges charging $2000/year, or at least very few. Raising tuition to $4000/year increases the income of the college at no cost to the students, so any sensible college now charging less than that will do so. (our emphasis)

In this stylized example, it is obvious that tuition will be increased for the low-tuition schools, as Friedman describes.  For most students, however, this concern is immaterial, because their tuition is well over the $4000 limit.

But Friedman omits an important part of the picture.  While other students may not suffer immediately, it is very likely that the tuition of more expensive schools also will rise as a result of this policy. Let’s continue Friedman’s logic forward.

If community colleges, whose original sticker price is $2000 per student, raise their tuition and now are taking in twice as much money from tuition, they will be able to add additional services to their schools. For reasons we’ve expounded on in the past, these services are unlikely to measurably improve the quality of education.  What they almost certainly will do, however, is grow the school’s bureaucracy and provide perks to students. In response, colleges whose actual costs are higher than $4000 will need to provide similar perks to compete.  Providing these perks raises their cost, and so they will need to raise tuition as well.

Now, since the tax credit doesn’t cover anything beyond the $4000 threshold, students at these colleges will face higher tuition. Over time, this tendency “works its way up the food chain,” until all colleges have these additional perks, programs, and costs.

It is easy to see why any sort of government aid will result in similar tuition increases. The students who will be particularly affected by this trickling-up effect are those who don’t qualify for many of the government programs: they suffer the same tuition increases without receiving the corresponding government aid. Situations like this demonstrate precisely why government aid directed at schools ends up being simply wasteful, and why subsidizing students directly makes much more sense than subsidizing schools.

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  1. […] idea. While it’s true that government-subsidized student loans are a major contributor to the rapid increase in tuition costs, so long as they exist, they should be administered as efficiently as possible — rather than […]

  2. […] the best prescription is to cut out all middlemen, wouldn’t the most logical conclusion be to eliminate the government’s role in education […]

  3. […] as donors can choose exactly where their money goes and what it is used for. Given all the other problems of government aid, we find the donor-driven model the clearly superior […]

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