Why Does Tuition Go Up? Because Taxpayer Support Goes Down

In a speech at the University of Michigan at Ann Arbor in January, President Obama called on public colleges that benefit from subsidies, grants, and government loans to rein in the tuition increases that have characterized higher education for well over a decade. "We can't just keep on subsidizing skyrocketing tuition," he said.

The president's plea for moderation was supported by a threat to directly intervene to reduce or even eliminate expanded federal programs to colleges that fail to comply. The presentation was greeted enthusiastically by students, politely received by some university administrators, and criticized as being interventionist by some legislators.

Is the assessment that federal programs "subsidize" higher tuition correct? There are two rather different points of view used to account for rising tuition in public higher education. One is the "market power model," presumably accepted by the president. It asserts that subsidies and grants to students increase demand, which gives colleges more ability to raise tuition. The second is the "spending constraint model," which argues that rising tuition is the obvious consequence of declining state appropriations.

According to the market-power view, grants, aid, and subsidized loans will boost student demand and lead to higher "sticker prices." Under this explanation, colleges do not pass on to students all the revenue generated from Pell Grants and the Stafford Loan Program by offering lower net tuitions. At its extreme, this point of view has been labeled the "Bennett hypothesis," after former Secretary of Education William J. Bennett, who formulated it. The theory's main idea is that federal grants increase revenue but do little to increase enrollment.

If the market-power model is the best explanation for rising tuition, what are its implications? In theory, if there were a monopoly provider of education services, it could respond to a government grant per student by increasing the sticker price, reducing the net tuition that students pay, and thereby accommodating some increase in enrollment. A working rule of thumb for this case is that listed tuition will rise by 50 cents and net tuition will drop by 50 cents for every dollar increase in the subsidy.

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