Education: Up the Academy

Clinton's college-aid hikes would help schools, not students.


On Valentine's Day, President Clinton spoke to an audience in San Francisco that had every reason to love him: the American Council on Education, the chief lobbying organization for the nation's colleges and universities. Just a month before, in his State of the Union message, Clinton had pitched several ideas—such as expanding the federal Pell Grant and direct student-lending programs and making college tuition expenses of up to $10,000 deductible for families making under $100,000 a year—that higher education leaders absolutely adored.

Clinton had chosen the ACE meeting to draw a line in the sand. The Republican Congress, he said, just wants to "cut and gut" government aid to higher education, perhaps even eliminating the Department of Education altogether. "I want you to know that to all of this, I will say no," the president promised. "I will fight these proposals every step of the way."

The crowd cheered. As well they should. Despite the talk of helping struggling families afford higher education, Clinton's policies, if enacted, will actually make it easier for colleges and universities to charge students more and more for tuition and other costs.

Paying more for college is, of course, something that people have almost come to expect. Tuition and fees for higher education have been going up for years. In the decade between 1983-84 and 1993-94, average tuition, room, and board for all institutions of higher education rose by a third in real terms; the price of private schools increased by 44 percent during the same period.

Not surprisingly, students and parents complain about how far into debt they must go to pay for school. Personal finance magazines are filled with articles on how to save for a child's college education. College administrators, waxing sympathetic, beg for more aid from Congress and state legislatures.

Interestingly, those same administrators, along with policy makers and the media, rarely try to explain why college costs are rising. Is land for new classrooms that much more expensive? Is there a shortage of people becoming professors, bidding up the wages of those currently in colleges and universities? Do books cost more than they used to? The short answer is maybe—but the cost increase in higher education far outpaces increases in any of those expenditures.

In fact, the cost of higher ed is rising because there isn't a true market for students. Governments, both federal and state, subsidize colleges and universities—even private ones—so heavily that tuition and fees have only the murkiest relationship to the costs of providing higher education. The "costs" themselves are essentially arbitrary.

Much like the cost-plus system of paying for health care, in which third-party payers such as insurers now cover most of the immediate cost of consuming medical services, the system we use to finance higher education encourages the expansion of noninstructional staffing and nonessential physical plant, rewards colleges for hiking tuition, and pushes many students into academic environments for which they are unprepared. Rather than boosting federal financial aid by 15 percent to $40 billion, as Clinton's budget proposes, Congress should consider whether any financial aid really serves the public interest.

Higher education is a huge commercial enterprise, made up of some 3,600 public and private colleges and universities spending about $160 billion a year and employing over 2.5 million people. Almost 50 percent of this industry, however, is financed directly by federal, state, and local governments, including direct appropriations, research grants and contracts, and Pell Grants for students. In the 1989-90 academic year (the latest data available from the Department of Education), 30 percent received federal grants averaging $1,770.

The actual role of government is even larger than that, however, because of the DOE's role in subsidizing and guaranteeing student loans. The government pays the interest on such loans for as long as the student is enrolled full time and subsidizes the interest rate for as long as the debt is outstanding. During 1989-90, about 28 percent of full-time undergraduates participated in one of several federal student loan programs, receiving on average about $2,660. Including work-study and some other assistance, fully 42 percent of all full-time college students got an average of $3,511 in grants and subsidized loans from the federal government. Compare that to the average cost of tuition, room, and board in American colleges and universities that year: $6,207.

Private institutions, of course, get less of their money from the government than do public institutions, but not by as much as you might think. Direct support, including Pell Grants but excluding other government student aid such as loans, made up over 20 percent of private schools' revenue in 1989-90 (the figure for public schools was 55 percent). And students at private schools are even more likely than their public counterparts to receive government grants and loans, no doubt because the nominal tuition they pay is much higher.

With a pot of government money sitting out there waiting to be tapped, there's a strong incentive for college administrators to raise tuition. Consider how financial aid works: The federal government awards student aid according to how much a student's tuition and fees exceed his or her "expected family contribution"—a figure calculated from family income and assets, the number of children, and other measurements. Since a college or university knows the average expected family contribution of their student body, it makes sense for administrators to boost their charges above that amount—thus making more students eligible for aid. Families will pay more, but a good portion of the tuition hike will be picked up by the government. Hence, colleges and universities can get more money for providing exactly the same service.

Administrators, of course, make the opposite argument about government aid and tuition. They say that colleges and universities have had to hike tuition to make up for cuts in federal and state assistance. While this argument plays well in soundbites, the actual record of the past two decades makes it difficult to swallow.

During the 1970s, the real-dollar value of government assistance to higher education, adjusted for the number of full-time students, fell slightly. So did real tuition, room, and board charges for both public and private colleges. Throughout the 1980s, however, government assistance per full-time student rose significantly (10 percent, not including loans), accompanied by a 27 percent real rise in public college charges and a staggering 50 percent real rise in private college charges. College and university revenue from Pell Grants rose by more than 25 percent from 1985-86 to 1991-92; revenue from state-level need-based grants rose by about 15 percent, even as colleges were complaining of massive cutbacks in government aid. In short, administrators' claims that a drop off in government aid necessitated tuition hikes are untenable—they run counter to both the available evidence and basic economic theory.

This is the context in which Clinton's proposals on higher education finance should be examined. His suggested expansion of the Pell Grant program means more money for colleges to spend hiring nonteaching staff, building monuments to academic extravagance, and subsidizing college athletics (yes, all but a handful of NCAA teams lose money for their universities).

Clinton's proposal to expand direct lending is more complicated. The system it would replace—government guarantees of loans by private banks—is itself horribly flawed. The largest federal loan program, the Stafford Loan, was created in 1965 and, until recently, provided four out of every five student-loan dollars nationwide. The Stafford program gives private lenders a "special allowance," set 3.1 percentage points over the 91-day Treasury bill rate, to pay for the interest on loans issued to college students.

Stafford loans are insured against default by a guaranty agency and reinsured by the federal government. If a student defaults and the private lender fails to collect the debt, it is fully reimbursed by the guaranty agency, which, in turn, is fully compensated by the federal government if it fails to collect the unpaid balance. Not surprisingly, few participants in this process have any incentive to reduce defaults, which occur about one-fourth of the time.

The selling point of Clinton's direct-lending scheme, passed as a pilot program last year, is that it would eliminate the private middlemen and have the Education Department issue loans directly to students. The administration claims this will save the government billions of dollars a year, but we won't be able to gauge that for another six to eight years, when the loans start to come due. Without waiting for the results of this experiment, Clinton wants to increase dramatically the number of loans directly issued by Washington.

The payoff of direct lending may not be known, but we can guess using common sense: Why should we expect the federal government to be a better lender than a private bank? Indeed, when the Senate Subcommittee on Investigations for Governmental Affairs investigated the Education Department's handling of student loan-guarantee programs a few years ago, it found that the DOE "failed to efficiently or effectively carry out its responsibilities….It is not an exaggeration to say that we have heard no testimony or seen any document that suggest that the Department of Education has done even an adequate job in managing and overseeing its student loan responsibilities." Giving the department more responsibility is not likely to improve this sorry record.

It is probably true that, federal loan programs or no, the vast majority of students would still need to borrow some money to attend college. I see no reason why these loans shouldn't be made by private lenders who, without government guarantees, are simply making a business decision to invest in the future earning potential of students.

Would the lack of government guarantees mean that the market in student loans would completely dry up? It's unlikely. Banks, after all, make money by lending, and the fact that the overwhelming majority (more than 75 percent) of student loans are repaid on time indicates that promising students are good risks.

The withdrawal of federal guarantees would force lenders to seek out students (or students' parents) who are likely to repay their loans. If private lenders prove reluctant to reenter the market for student loans, colleges and universities could prime the pump by making loans themselves and then selling the loans on secondary markets for maintenance and collection, as some private colleges already do today. Or schools—who have more ready information about their students than banks are likely to—could simply make loans themselves, earning interest on their endowments while funding their students.

This shift to private-sector lending wouldn't mean that only accounting and engineering majors would get loans. A responsible student majoring in an "impractical" subject—say, art history—may be a better risk than a less-devoted student working toward a "practical" degree.

Clinton's plan to make tuition payments tax deductible seems less objectionable on face value. But simply making tuition tax deductible, the Clinton approach would still artificially encourage families to buy higher education rather than other goods and services, leaving colleges and universities with no strong incentive to deliver more bang for the education buck.

As Clinton was inside San Francisco's Hyatt Regency Hotel that February 14, whipping lobbyists for higher education largess into a frenzy, several hundred people protested outside the hotel against Clinton's multibillion-dollar loan-guarantee plan for the Mexican peso. Why should we back loans so risky that banks won't make them? the demonstrators argued. In a few years, if Clinton's college aid plan makes it into law, we may well have another loan-guarantee fiasco to worry about.