Pushing on a String

In their last moments in power, Senate Republicans want to examine whether federal education tax benefits like the HOPE Scholarship tax credit have contributed to college tuition increases. What theyll find, if they look closely, is a complicated relationship.

First, let's be perfectly clear. The research indicates that federal financial aid is not the main driver of college cost increases. It's bad state government behavior. According to the National Center on Education Statistics, college tuition is going up because of a decline in state funding for higher education more than anything else.

The big percentage increases in college tuition that have occurred over the last several years have been seen at public institutions of higher education (i.e. state and community colleges), which educate three-quarters of all post-secondary students. Why have the increases occured there?

When states run deficits, they are required by state law, often state constitutional law, to balance their budgets. Governors tend to respond by cutting state funding to higher education, because they know the cuts can be back filled through higher tuition and that those tuition costs can be covered by student borrowing in the main. In the first part of the decade, states were continually in fiscal crisis and confronted large deficits. Accordingly, tuition jumped between 2001 and 2005. But as the state fiscal picture improves, we expect the rate of growth in state and community college tuition to decline.

Now to the extent there is a relation between higher tuition costs and federal education tax benefits, we suspect it is occurring through the back door of financial aid leveraging.

Yes, colleges could use the presence of federal education tax benefits as a rationale to increase tuition costs, just as prescription drug companies could use the presence of a Medicare prescription drug benefit as a rationale for driving up drug prices further. Even the Clinton Administration-affiliated academic partially responsible for creation of the main federal education tax benefits has recognized that price inflation is a danger. In fact, Clinton Secretary of Education Dick Riley wrote a letter to college presidents in 1998 advising them not to raise tuition in response to federal education tax benefits or else . . . after learning it was the intention of some.

But as to the mechanism of how colleges would use the presence of federal education tax benefits to increase tuition costs -- most likely it would not be by raising tuition across the board in an amount equal to federal education tax benefits. That would be crass, likely lead to a political backlash from federal policymakers, and not make sense since most education tax benefits are targeted to families making less than $107,000.

Rather, colleges are more likely to increase costs in response to federal education tax benefits through a back door practice called enrollment management and financial aid leveraging. As we noted earlier this week, under these enrollment management programs, a college with the help of an outside company (e.g. Sallie Mae's subsidiary, Noel-Levitz or the College Board) discerns how much money beyond what the FAFSA tells them a family can and is willing to pay for their institution. These enrollment management companies take a look at higher ed tax benefits (not included in the FAFSA need analysis calculation), home equity (often not considered by the FAFSA need analysis calculation), and most importantly private loan eligibility and credit scores. The college takes that information and then cuts back on its own institutional grant aid giving to specific needy students, thus driving up net tuition price for those kids. That means in these specific situations, you've got tax benefits leading to higher net prices for specific needy kids, because of the bad behavior of colleges.

As the Atlantic Monthly has described, a college will take a $20,000 institutional grantfull tuition for a needy student a elite private universityand break it into four separate institutional "merit" scholarships of $5,000. These "merit" scholarships are targeted not to particularly high achieving students, but to regularly qualified but wealthier students who probably would not attend the relevant college without the $5,000 discount. Lured in by the $5,000 "merit" scholarship, these wealthy students then pay their remaining outstanding $15,000 tuition costs. Over the course of four years, the college reaps an extra $240,000 for the four merit students. Its not terrible until you see what it does to the economic diversity of a school, not to mention student indebtedness, particularly for the low-income students who see a decline in institutional "need-based" scholarships.

Hundreds of colleges subscribe to Sallie Maes enrollment management service, and hundreds more use related services offered by not-for-profit organizations, such as the College Board. Once a college has determined that it wants to use these mechanisms, it buys specially made software from College Board and off it goes. There is no federal prohibition against the practice of colleges considering federal education tax benefits in the packaging of their institutional financial aid.

The coming Senate Finance Committee hearing could be a tedious repetition of tired economic theory about the relationship between government aid and price. It could be another opportunity for Democrats to push their message that the college affordability problem is based on big federal loan subsidies going to banks like Sallie Mae that don't need help, instead of students and families who do. Or it could be the start of a more serious and comprehensive discussion of how to make a college education more affordable for all. We hope it's the latter.