Does Financial Aid Drive College Costs Up?

In 2006, the rate at which the cost of tuition at U.S. colleges and universities increased at a rate of 6.71%. By comparison, the rate at which inflation increased in the general U.S. economy was just 3.23%, less that half the rate at which the average U.S. university jacked up the price of tuition at their institutions.

These numbers are provided by FinAid, one of the most comprehensive sources of student financial aid information we've found on the Internet.

But a better question is: Why should the cost of tuition rise so much faster than inflation?

Gary Wolfram of the Cato Institute examined data going back to 1977 in a 2005 paper, in which he found a very high correlation between financial aid increases and tuition hikes. What though is less clear is how much of the high rate of tuition inflation is due to increases in the amount of financial aid provided by the U.S. federal government.

That murkier picture was described in recent Senate testimony. In December 2006, Harvard's Dr. Bridget Terry Long noted that given the complexity of federal financial aid programs, it would be difficult to assess how much an impact it would have in increasing tuitions. Instead, she focused her testimony on several other separate factors that would seem to also play a role:

1. Reduction in the Amount States Provide to Public Colleges and Universities
   
2. Higher Labor Costs for Faculty and Staff
   
3. New Expenses (Technology, Student Services)
   
4. Financial Aid Provided by the College or University Itself
   

These factors are no strangers to America's higher education policymakers, including those at the University of Pennsylvania. Back in 1998, several members of the University's Cost Containment Committee acknowledged all these factors to some extent in an article for the University of Pennsylvania's Almanac.

Where they differed from Dr. Long's assessment however was in presenting how university policymakers view financial aid in setting tuition rates. Here, UPenn's policymakers provided this essential glimpse as they were specifically responding to whether the schools within the University of Pennsylvania had a structural deficit:

First, financial aid is directly tied to tuition; if not for the higher level of financial aid expenditures, we would not have been able to increase tuition rates over the past ten years at the levels we did and still, at the same time, maintain a world-class student body. Any discussion of financial aid expenditures decoupled from tuition revenue presents an incomplete and inaccurate picture.

The remainder of the statement goes into a description of the funding for different university budgets. For our purposes however, there are two ways to read this statement. First, one could argue that if not for increases in financial aid, they would have increased tuition more.

This seems unlikely. According to FinAid, the average rate of tuition increase for all U.S. colleges and universities in those 10 years from 1988 to 1998 was 7.44%. General inflation in the U.S. was 3.33%. In the absence of specific data for UPenn, we assume that the University of Pennsylvania increased its tuition prices by this average rate throughout this period. Frankly, we're not sure how much more "world-class" maintenence they could get away with charging UPenn's student body.

The other reading of UPenn's policymakers' statement is that the increases in financial aid available to students allowed them to charge substantially higher tuition fees than they could otherwise. Higher levels of financial aid allow the colleges and universities to charge higher tuitions, as the students themselves would effectively only have to pay the difference between the higher tuition rates for the classes they take and the amount of financial aid they receive.

The university, in the meantime, gets all the money in that transaction. It would then appear to us that increasing financial aid does indeed drive college costs up as the motive, means and opportunity to do so are all present.

Previously on Political Calculations

• Saving for College
  

Update: Corrected grammatical errors produced by our Department of Redundancy Department!