President Obama is holding thinly-veiled campaign events at college campuses around the country touting his plan to retain low interest rates on federal student loans. Amidst the debate over whether a temporary 3.4 percent interest rate passed in 2007 should be retained and, if so, how to pay for it, a far more important question has been ignored:
Who really benefits from the $65 billion-plus that Washington spends each year on student aid?
Recent economic research suggests that colleges siphon off a significant portion of federal education aid rather than lowering costs to students. Simply put, much of federal student aid is corporate welfare for colleges.
WHO REALLY GETS THE MONEY?
Annual earnings for bachelor's degree holders are $30,000 higher than for high school graduates, making a college diploma a prerequisite for entrance to the middle class. But as the College Board reports, from 2001 through 2011 tuition for public colleges increased by an average of 5.6 percentage points higher than inflation, while private college tuitions rose 2.6 percent above inflation. Tuition, housing and other expenses at public institutions today tops $21,000 per year. Double that if you want to attend a private colleges charging.
In response to rising tuition costs, federal aid such as Pell Grants, work-study programs and tuition tax credits have more than tripled over the last decade, reaching $65 billion in 2011. Washington also made over $100 billion in subsidized student loans last year.
But is all this college aid actually making college more affordable? At first glance, the answer is obviously yes. But there's an alternative story, in which colleges and universities can siphon off a portion of federal education dollars. Economists would term this a question of the "incidence" of federal aid, of who ultimately benefits from it.
The most obvious way that colleges might capture federal student aid is by raising tuition. Research to date has been inconclusive, but Stephanie Riegg Cellini of George Washington University and Claudia Goldin of Harvard have provided compelling new analysis. Cellini and Goldin looked at for-profit colleges, utilizing the key distinction that only some for-profit schools are eligible for federal aid. Riegg and Goldin find that that aid-eligible institutions "charge much higher tuition ... across all states, samples, and specifications," even when controlling for the content and quality of courses. The 75 percent difference in tuition between aid-eligible and ineligible for-profit colleges -- an amount comparable to average per-student federal assistance -- suggests that "institutions may indeed raise tuition to capture the maximum grant aid available."
HOW COLLEGES EAT YOUR AID
An alternative way that colleges can capture federal aid is by reducing their own student assistance. This is a particularly effective approach, since students receive widely differing amounts and are unaware of what they might receive in the absence of federal assistance.
Writing in the Economics of Education Review, Nicholas Turner, a Treasury Department economist on leave from the University of California, analyzed colleges' responses to student eligibility for tuition tax credits. Programs such as the American Opportunity Tax Credit allow up to $2,500 tax credits for tuition costs, a benefit that flows mostly to the middle class. Turner found that roughly four-fifths of the benefit students receive from tuition tax credits is lost through reduced student aid provided by colleges.
Pell Grants focus more on lower-income households. Lesley J. Turner, a doctoral candidate in economics at Columbia University, analyzed how institutional aid changed as students became eligible for Pell Grants. She found that, on average, "institutions capture 16 percent of all Pell Grant aid." However, important differences exist. Public colleges and universities garnered very little Pell money. But selective private colleges -- the ones parents really want their kids to attend -- claw back 79 percent of the value of Pell Grants.
Together, these studies imply that tens of billions of dollars in federal educational assistance may be siphoned off by educational institutions rather than making college more affordable for students.
THE CASE FOR MAKING THE MIDDLE CLASS ANGRY
Where does this money go? One possibility is higher salaries. But while superstar professors' salaries have increased rapidly, overall full-time faculty salaries have risen only slightly above inflation over the past decade, according to the American Association of University Professors. A more likely suspect is administrative staffing, where the number of employees per 100 students has risen by 13 percent over the past decade. The largest increases in both salaries and staffing have been for private universities, bolstering the view that private schools have greater abilities to capture federal dollars.
Simply scolding or threatening colleges over rising tuition, as public officials -- including President Obama -- have done for decades, is unlikely to succeed. Given the multiple avenues by which colleges can capture federal dollars, enforcement would be difficult.
A better approach would focus on market pressure. Colleges can most easily capture federal aid when it flows to prospective students who do not truly "need" it, meaning students who would likely attend college anyway. For marginal students, those for whom federal assistance makes the difference between attending and not, economic theory suggests that colleges could capture less.
There is already plenty of incentive to attend college. The average student loan balance of $25,000 pales next to the extra $1 million a Bachelor's degree holder will earn over his lifetime relative to a high school graduate, according to a 2002 Census Bureau study. Focusing student aid to the truly poor would enrage many middle class parents, but that's the point: to make them truly angry at rising costs and unwilling to keep paying them.