As Congress gears up to pass a bill that will reauthorize higher education spending for the next few years, members should shift down to a lower speed and begin to read the signs.
In fiscal year 2005, the federal government will spend more than $70 billion on financial aid without clearly knowing what that money will produce.
Over the last half century, federal aid to students has created unintended consequences: skyrocketing tuition and more red tape for colleges and universities. With the Higher Education Act coming up for reauthorization this year, Congress should use this opportunity to examine more efficient ways of funding higher education.
The last decade has been marked by rapidly increasing federal aid and ballooning tuition. In current dollars, money for Pell grants -- federal grants to less affluent students -- rose from less than $5 billion in 1996 to more than $12.8 billion in 2005.
In addition, federal Perkins loans -- low interest federally guaranteed loans to roughly the same group that is eligible for Pell grants -- rose in current dollars from $892 million in 1993 to $1.3 billion in 2004. The Federal Direct Student Loan Program and Federal Family Educational Loans went from a combined $12.5 billion in 1993 to $52.2 billion in 2004. Tax credits and deductions will add another $9 billion in 2005.
Not surprisingly, this massive influx of student aid has been accompanied by a substantial increase in tuition. In the 10-year period ending in 2004, tuition and fees at public colleges and universities rose 47 percent, adjusting for inflation. At private colleges, they rose 42 percent.
And the trend is continuing. Average tuition and fees for in-state students at four-year public colleges and universities rose 10.5 percent in 2004-05 to $5,132. This marked the fourth straight year where tuition and fees rose by more than 5 percent in inflation-adjusted dollars at public four-year institutions. Private school tuition and fees rose by 6 percent in the same period to $20,082.
Anyone who has taken a remedial economics course knows that if you subsidize something, more people want it. This increase in demand will push up the price. Former Secretary of Education William Bennett recognized this in 1987 when he argued that increases in federal aid have "enabled colleges and universities to blithely raise their tuitions, confident that federal loan subsidies would help cushion the increase."
The U.S. government has helped to create a cycle where federal aid results in increased tuition, leading to political pressure to further increase aid. This in turn leads to higher tuitions.
It is difficult to estimate with laser-guided precision the amount of the increase in tuition due to federal student aid programs. But clearly these programs raise tuition while distorting the choices of individuals, as well as the behavior of educational institutions and state legislatures. The subsidies also reduce the independence of our higher education system by tying colleges up, mummy-like, in red tape.
It therefore makes sense that Congress should reduce the federal government's role in funding higher education and find better ways to harness market forces to fund college tuitions. To an extent, this is already happening: the private sector is providing a greater percentage of student loans. Nonfederal borrowing has increased from seven percent to 16 percent of education loan volume over the past five years. Nonfederal borrowing reached $11.3 billion in 2003-04, up 39 percent in real terms over the previous year and almost 150 percent in three years. Private loans made up $10.6 billion of these loans.
Still, the private portion of overall student aid is low. A good way to increase private sector help might be to allow for human capital contracts. Nobel laureate economist Milton Friedman suggested using something like this 50 years ago: Anyone who wants to attend college could enter into a contract whereby she would agree to pay a certain percentage of her salary for a specified number of years to investors who would pay her tuition.
It's worth a shot. This and other market-based systems would be more efficient ways of funding higher education than the car wreck that the federal government has made of college aid.