Wednesday, November 22, 2006

Financial Aid Increases and the Law of Unintended Consequences

By Richard Vedder

Before I forget it, read Wick Sloane's great column in today's INSIDE HIGHER ED. It is a gem.

On to business. The Democratic promise to ramp up financial aid and reduce interest rates on loans led me to dig out some regressions that the Whiz Kids have run on the relationship between tuition fees and grants and loans. The results below, using data for 1971 to 2002, are confined to public universities. We (CCAP) find:

1. That for every new dollar of grant made per student, tuition rates rise by somewhere between 35 and 40 cents per student, meaning the net financial gain to the student is very substantially less than what would appear to be the case.

2. The relationship between loans and tuition is smaller per dollar of loan, as is the grant-tuition relationship at two year public schools.

These findings are provisional, and could be altered with different data sources, different years, different methodologies. None the less, they conform with the expectations of economic theory: bigger grants (e.g., Pell Grants), are far less effective than planned because they increase the ability of schools to raise tuition fees. Indeed, higher Pell Grants might help some lower income kids go to school, but lead to some other slightly better off students to forego college because of the higher tuition. If those foregoing school are better students than those induced to go to college by bigger Pell Grants, it is entirely possible greater aid might lead to lower long term graduation numbers relative to the 18 to 24 year old population. Moreover, if bigger grants lead to higher fees for part-time adult students not receiving aid, this problem is compounded.

What about interest rate subsidies? The Dems propose slashing interest rates in half. As an economist, I much prefer overt subsidies to disguised ones in the form of below-market interest rates. Don't mess with market forces, at least directly. But interest rate subsidies are the equivalent of a grant, not a loan, since they lower the cost to those students with loans. Thus my suspicion is this move would aggravate the tendency for tuition fees to rise.

Given the anti-equal opportunity bent of most American top colleges (discussed earlier), there is a decent humanitarian case to be made for expanding Pell Grants as an equal educational opportunity move, even if the positive impact on the impacted students is less than intended. However, the case for interest rate subsidies and tax benefits (which primarily serve the middle and upper classes) is extremely weak. It probably would be asking too much to ask our President to veto an expenditure bill -- he seems temperamentally incapable of making such a move. But hopefully Senate Republicans will use their considerable filibuster powers to effect a compromise that does less harm than the initial Pelosi proposals.


superhiker said...

I'm pretty skeptical about a simple cause and effect relationship between financial aid and rising tuition levels.

A correlation does not mean a cause; just because tuitions have risen with financial aid, doesn't mean that they won't keep increasing if financial aid is cut.

A test has been done: state universities that have had their state subsidies cut have certainly not responded by reining in total expenditures per student (tuition + subsidy).

Instead, what has primarily happened is tuitions have gone up.

That is is certainly the case where I work.

The students who can't afford the higher tuition are simply out of luck, unless they can get some of the relatively small amount of increased financial aid.

Butter Cup said...

Much Better.

100Student said...


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Student loans repayment can be a real nightmare without adopting some strategies that would help the new graduates to organize their social and financial life. Here are some strategies they can use to do this:
- An additional part-time job;
- Freelancing is another option (meaning that they can do particular pieces of work for different organisations, without working all the time for a single organisation);
- They should try to keep their living expenses as low as possible (live in a smaller apartment, live with a roommate to share some of the expenses, find an apartment that is closer to the job, to eliminate the extra-expenses for transport etc.);
- To apply for forbearance (this is an immediate solution for hard times when the new graduate is in impossibility to re-pay the amount of money and the need for student loan consolidation becomes apparent; it is a temporary period, when the graduate can postpone or delay his or her re-payments until a later time on a federal or direct loan after the beginning of the re-payment, and when the student doesn’t qualify for deferral). The forbearance must be applied through the lenders of the loans.
- To consolidate the payments.
If you feel this helps, please drop by my website for additional information, such as federal student loans information or additional resources on private student loans .