By Richard Vedder
The major difference between the for-profiit, market-driven sector of the economy and the not-for-profit sector is that incentives in the latter sector favor efficiency-enhancing measures that keep price increases down, a tendency helped by the existence of competition. Companies that cut costs increase their profits, and with that there are bigger profit sharing bonuses for key workers, capital gains from stock options for top managers, and huge increases in wealth and income for stockholders. Those incentives are largely lacking in the not-for-profit university sector that dominates American higher education.
One strategy to reduce tuition increases would be to try to become more efficient by emulating to some degree the incentives of the market. There are a variety of different ways it can be done.
One approach would be for state governments to tie appropriations to tuition price containment. For example, the legislature could give university A a 5 percent appropriation increase if it keeps it tuition increase to the rate of growth of family income or less, but reduce that apropriation by some amount, say one percent, for each one percent tuition increases exceed the growth of family income. This implies a sort of tax on excessive tuition increases, and sharply lowers the incremental income universities can earn from tuition hikes. Presumably, that may force universities to adopt more austere budgets and make more internal cost savings. This make seem like it smacks of price controls, but it is really rather different. Price controls apply to situations where the price of the good sold accurately reflects the costs of producing the good, which is decidedly not the case in higher education owing to massive subsidies. The scheme here ties the size of subsidy to university willingness to meet broader social goals.
Another approach would be for state governments to provide financial bonuses for university presidents and other key employees if certain key efficiency criteria are met. If per student spending rises by less than the rate of inflation (as determined by an outside auditing agency), for example, the president, provost, and other key employees could receive bonuses of, say, $50,000 to $100,000 a year. University presidents are under enormous pressures to increase costs and spending, and these financial incentives might offset the deleterious effects of the spending-enhancing pressures currently faced. Bonus payments ideally would not merely apply to costs, but also at outcomes (or, better yet, productivity, which relates to outcomes per dollar of resources expended). If it can be demonstrated students are learning more, they are dropping out of school less, they are completing their degree on time instead of over 5 or 6 years, etc., bonuses could be meted out. Legislators could require trustees of state universities to develop such incentive systems. Universities would no doubt try to find ways to circumvent the rules to earn bonuses that are undeserving, etc., so the devil of this approach is in the details. Nonetheless, it is an approach that deserves serious consideration.