Policy Analysis No. 531

Making College More Expensive: The Unintended Consequences of Federal Tuition Aid

By Gary Wolfram
January 25, 2005

Executive Summary

As Congress debates the reauthorization of the Higher Education Act, it should heed Friedrich Hayek’s warning that democracy is “peculiarly liable, if not guided by accepted common principles, to produce over-all results that nobody wanted.” One result of the federal government’s student financial aid programs is higher tuition costs at our nation’s colleges and universities. Basic economic theory suggests that the increased demand for higher education generated by HEA will have the effect of increasing tuitions. The empirical evidence is consistent with that—federal loans, Pell grants, and other assistance programs result in higher tuition for students at our nation’s colleges and universities.

The diversity of objectives, resources, and types of governance among the thousands of colleges and universities makes it difficult to adequately measure the exact amount by which tuitions rise in response to federal student assistance. Therefore, estimates of the amount vary in the literature. Congress can at best know that its policies increase tuitions and that some portion of the federal assistance ends up being captured by state governments and by the colleges and universities.

Also, when large numbers of students begin to rely on the federal government to fund their higher education, and the federal government uses this financing to affect the behavior of state and private institutions, we should be concerned about how the resulting loss of independence of our colleges and universities affects the ability of voters to form opinions about public policy that are independent of the government’s position.

Rather than expand the current system, Congress should consider a phase-out of federal assistance to higher education over a 12-year time frame. As the federal government removes itself from student assistance, we should expect several things to happen. First, sticker tuition prices should decline. Second, the private market should respond to the phase-out of federal assistance. That response would likely take three forms: additional private-sector loans, additional private scholarship funds, and perhaps most importantly, the expansion of human capital contracts. Human capital contracts, first suggested 40 years ago by Nobel Laureate Milton Friedman, would allow students to pledge a portion of future earnings in return for assistance in paying their tuition.

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Gary Wolfram is George Munson Professor of Political Economy at Hillsdale College in Michigan.