Alternative Theories for Rising College Tuition: State Funding and Competition

In my last post I wrote about the Bennett Hypothesis. The basic idea is that federal subsidized loans cause tuition to increase, but the evidence supporting this hypothesis is ambiguous at best. In 2013, the Wall Street Journal brought together three economists to voice their ideas on rising tuition costs. While they disagreed about the exact relationship between federal aid and tuition, they provided two alternative theories as to why college tuition is increasing: consistently decreasing state funding and competition between colleges.

Decreased state funding

Government Accountability Office, State Funding Trends and Policies on Affordability, Table 3[i]

Dr. Fichtenbaum, professor at Wright State University, stated that the decline in state support for higher education has been one of the most important factors driving up prices at public universities. As this data from the Government Accountability Office shows, 2012 is the first time in the last decade that students are paying more in tuition than state sources’ contribution to higher education. The 8.45 percent decrease in state funding from 2003 to 2012 was matched almost equally by an 8.23 percent increase in average net tuition (estimated tuition after grant aid is deducted) during this period. A Federal Reserve Bank of New York post shows that decreasing state funding for higher education leads to an increase in public school tuition rates.

This trend in decreased state funding isn't a recent issue either. Since 1980, average state fiscal support for higher education has been on the decline, according to the American Council on Education (ACE). Even more strikingly, ACE is concerned about state funding for higher education hitting zero. Extrapolating past and present trends in funding, they estimate that all state funding could hit zero in 2059, with some states stopping funding as early as 2032.

While these trends have plenty of time to reverse themselves before 2059, it is important to keep in mind their current impact. Decreased funding, coupled with the evidence provided by the Government Accountability Office and Federal Reserve Bank, means that tuition hikes might not end any time soon.

Competition increases prices

Both Dr. Fichtenbaum and Dr. Vedder, director of the Center for College Affordability and Productivity, mention the cost of competition among colleges. An article from the University of Colorado – Denver studies the phenomenon of increasing competition leading to increasing prices in higher education.

As lower-quality schools (estimated in this paper by two-year colleges) enter the market, both private and public schools must differentiate themselves to signal quality. To do this, the paper argues, both private and public schools raise their sticker price (the amount schools advertise as tuition), but only public schools raise their paid price (the advertised tuition minus grants and scholarship) for all students. Private schools, on the other hand, are likely to give increased subsidies to higher quality or low income students while increasing the paid price for other students, overall keeping the same average paid price.

The Huffington Post and Forbes argue for another way increased competition could raise tuition; colleges differentiate themselves by prestige, and prestige is expensive. Ivy League schools don’t boast about their excellence in college affordability, but their top-tier faculty, state-of-the-art facilities, and plethora of research center. Their prestige costs money, and this cost is passed on to the students.

Though federally subsidized student aid may make tuition increases possible, it is likely that other sources ultimately cause the increases. Both decreased state funding and increased competition are likely culprits of tuition hikes, but they are not the only alternative theories. In my next post I will talk about Baumol’s Cost Disease and Bowen’s Rule.

[i] “Tuition” includes revenues from all tuition and fees assessed against students, net of refunds and discounts and allowances, for educational purposes. “Local” sources refer to funds provided and grants made by local government. “State” sources refer to funds received by colleges directly from a state legislature or through grants and contracts from state government agencies. “Federal” sources include appropriations for meeting current operating expenses, grants, contracts, and federal grant aid to students such as Pell Grants. “Other” sources include private gifts, grants and contracts; sales and services of educational activities; auxiliary enterprises; hospital revenues.

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