More on Pell Grants and Tuition

Here is a little sheet that provides a summary of the evidence on potential links between the Pell program and college tuition setting. One interesting point: this is often presented as a left-right issue, but it’s not. The experts cited are not a politically monochrome group.


Pell Grants Not Linked to Higher Tuition

Do Pell Grants “cause” tuition inflation?

I spoke about this, and about trends in college affordability, at a recent NASFAA meeting in Washington. You can see my remarks in the video linked at the bottom of this post.

But let’s address the question directly. The idea that federal subsidy is the root of all evil — in this case a major cause of price inflation in higher education — is well established in the popular writing about higher education. Former Education Secretary William Bennett put the case very directly in his famous NY Times op-ed piece titled, Our Greedy Colleges.┬áThe thinking behind this proposition is simple supply and demand. Government subsidy pushes up demand, so up goes the price. Stories like this make the economics professor in me cringe. People armed with nothing more than Econ 101 in their toolkit often think they understand quite a bit more than their slender training allows. Why would one presume that the simple model of perfect competition, which presumes perfect information, a homogeneous product, and small, profit-maximizing firms engaged in atomistic competition, fully describes the market for higher education? Got me.

This is a “market” dominated by heavily subsidized non-profit organizations that do not maximize profit, or even revenue. Selective schools leave tons of revenue uncollected because they actually care, and care deeply, about the composition of the freshman class. The most selective schools actually charge a net price that is lower than the schools a bit below them in selectivity. The admission process is not about attracting more and more customers. It’s as much about culling customers down to the “right” ones. In that sense, admission is a two way street. Imagine Burger King rejecting business. Universities do it all the time. But I digress.

At the level of the college or university, cost per student is roughly constant as the school adds enrollment. For smaller schools, the cost per FTE student actually would fall if the school enlarged a bit, so growth is not a force for rising tuition. At the industry level, there is no evidence that the long run supply curve of seats for students is upward sloping. Places at Princeton may be fixed, but the numbers of seats in the university system as a whole is fairly elastic. In other words, the long run supply curve is flat. This suggests that tuition increases over the last generation are not driven by rising demand. They are driven by large economic forces that are buffeting the entire national and global economy. We spend a lot of time talking about those forces in our book.

When the Federal government raises the maximum Pell grant, this creates a lot of good options for universities.

  • Allow the increased Pell support to meet a greater portion of needy students’ needs.

Many schools do not fully meet need, and this forces students who wish to attend those programs to borrow more. If this is what schools do in response to higher Pell maximums then access improves. Note that this choice would have no effect on the list price tuition the school sets. And it would reduce the net price to needy students.

  • Reduce the school’s own need-based aid, and plow the extra funds into endowment for the future.

If a school made this unfortunate choice, the added Pell support would not improve access at all. But again, it wouldn’t lead to higher tuition either.

  • Reduce the school’s own need based aid, and plow the extra resources into improved programming.

Again, this choice wouldn’t do anything much for access, but it wouldn’t cause tuition to go up. This choice might help retention and graduation, if the programmatic improvements were targeted toward those goals.

  • Lastly, schools might respond to an increase in the Pell Maximum by reducing their overall tuition discount rate. Since discounting is a major force propelling the “list” price upward, anything that reins in discounting would tend to reduce tuition.
The empirical evidence on the Bennett Hypothesis is inconclusive. Using mostly panel data, the studies of the link between Pell Grants and tuition are all over the map. Bob and I are the only researchers we know who have tested the proposition using Granger Causality. We find that changes to the Pell maximum do “cause” an effect on tuition, but the link is contrary to Bennett’s assertion. Increases in the Pell maximum tend to reduce tuition in the years that follow.
Here’s the video: