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When profits, financial aid mix in higher ed

In a Feb. 18, 1987, opinion article in the New York Times, then-Education Secretary William Bennett claimed that increases in federal financial aid had permitted colleges and universities in the United States to “blithely” raise their tuition fees because they were confident that the federal largess on offer would “cushion” the tuition increase for students.

Several researchers have attempted to study whether this “Bennett hypothesis” is true. The many studies of this hypothesis have focused on public and non-profit institutions, and the results have been mixed. As a result, it has been difficult to convincingly demonstrate that post-secondary educational institutions have effectively captured federal financial aid by raising their tuition fees. In addition, public and non-profit institutions have claimed—with some plausibility—that since they are not in the business of profiting from the product they sell, they have no motivation for charging above-normal tuition fees.

Since Bennett’s contentious observation in 1987, the previously nascent for-profit sector in higher education has grown appreciably. Because the objective of this sector clearly is to make money, it makes sense to ask whether Bennett’s arguments apply to this sector. In interesting new research, the economists Stephanie Cellini and Claudia Goldin have shed valuable light on this question.

Cellini and Goldin begin by pointing out that under Title IV of the Higher Education Act of 1965, the federal government provides grants and both subsidized and unsubsidized loans to post-secondary students. In 2007-08, for instance, for-profit post-secondary institutions accounted for 23 percent of this federal aid—more than double their enrollment share of post-secondary students.

Now, it is important to understand two points about the for-profit sector. First, not all for-profit institutions participate in Title IV programs; in some states, the number of such non-participating for-profit institutions may well exceed the number of participating for-profit institutions. Second, the non-participating for-profit institutions are not insignificant. Even though they typically do not show up in U.S. Education Department records, they educate about 670,000 students a year.

Given this state of affairs, one way to determine whether the Bennett hypothesis holds is to compare the tuition fees charged for the same program by the for-profit institutions that are Title IV participants—and hence the beneficiaries of federal student aid—with the fees charged by those for-profit institutions that are not. Cellini and Goldin convincingly demonstrate that for-profit institutions that participate in Title IV programs charge a much higher tuition than for-profit institutions that do not participate in Title IV programs.

How much more do they charge? Cellini and Goldin estimate this tuition premium to be a staggering 78 percent.

The way federal financial aid for post-secondary students is set up, all else being equal, means an institution with higher tuition will have a higher cost of attendance and therefore a potential student will qualify for more grant- or loan-based financial aid. In this situation, for-profit institutions that take part in Title IV programs have all the incentives to raise their tuition above the cost of the education they provide and thereby capture a larger portion of the federal aid.

The pertinent for-profit institutions are behaving rationally, and it is clear that they gain from the status quo. But what about the students who are supposed to be receiving an education—do they gain? This depends on the loan component of their financial aid packages. The larger this loan component, the greater is the money that will eventually have to be paid back; hence, it is very likely that students lose from large tuition premiums charged by for-profit institutions.

Finally, by granting either an excessive or an unnecessary subsidy, Uncle Sam loses. Put differently, Uncle Sam loses because he ends up creating the circumstance in which a large portion of for-profit institutions are able to charge above-cost tuition to their students.

In his post-government career, William Bennett has often been criticized for, among other things, his intemperate comments and his gambling activities. Even so, recent research tells us that at least with regard to the Bennett hypothesis, he appears to have been sagacious.

Amitrajeet A. Batabyal is the Arthur J. Gosnell professor of economics at Rochester Institute of Technology. These views are his own.

2/20/15 (c) 2015 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email rbj@rbj.net.

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