Does Federal Financial Aid Make Colleges Raise Prices?

In American colleges and universities, financial aid packages are often need-based (see this example from Yale), meaning the school calculates the student’s ability to pay and then makes up the difference with loans and/or grants. It’s an admirable sentiment, but one upshot of this at many schools is that any outside scholarships students receive will be automatically deducted from that package because they increase student’s ability to pay. The school is in effect eating that scholarship.

William Bennett, Ronald Reagan’s Secretary of Education once argued that this kind of thing happens generally across higher education with respect to Federal financial aid (like Pell Grants), and is responsible for a lot of the huge and continuing price increases at American institutions. The “Bennett Hypothesis,” as it came to be known, said basically that increases in Federal aid were being eaten by higher education (in a less defensible way to be sure) and that cushion provided an excuse for year-on-year price increases several times the rate of inflation:

If anything, increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuitions, confident that Federal loan subsidies would help cushion the increase. In 1978, subsidies became available to a greatly expanded number of students. In 1980, college tuitions began rising year after year at a rate that exceeded inflation. Federal student aid policies do not cause college price inflation, but there is little doubt that they help make it possible.

 Is it true? One wonders how we could possibly disprove this hypothesis. A counterfactual example might be when federal aid is cut, but this study notes that a decline in federal aid is also linked to tuition increases. Strictly speaking, the hypothesis must be incorrect, but according to Andrew Gillen of the Center for College Affordability & Productivity, it’s hard to know:

Big picture: the story that emerges from the literature is that the evidence is mixed. The Bennett Hypothesis is neither confirmed nor denied (see the links here for examples).

He reframes the hypothesis thusly:

The second way in which this report differs from the Bennett Hypothesis is that it is explicit about when the effect occurs (and the types of aid likely to suffer from it). Specifically, aid will fuel increases in spending when it is given to students whose ability and willingness to pay is in excess of current costs at the school. Because costs and ability to pay vary by school, this implies that a much more nuanced view is warranted. The same aid program can have different effects based on the characteristics of the school and the students attending… Thus, lumping all federal aid together when analyzing its impact, or even all aid of a given type, is unlikely to yield accurate results. Unfortunately, public data on aid is generally only available in aggregate form (not student specific), which limits the extent to which we can analyze these issues.

A quick scan of the literature lends some support to this more nuanced approach, outlined in detail here. This study finds evidence for the effect, but only in “top-ranked private universities,” while this study finds it only for in-state students. But stepping back, this reframing seems vague to the point of being useless. Basically Gillen is saying that given the current data, there is no way to conclusively prove his hypothesis one way or the other. I would be interested to know exactly what kind of data Gillen would consider necessary to make that judgment.. Any experts on the topic out there?

On a related topic, see this article by Benjamin Ginsberg article on college administrators in our latest issue.

Cross posted at College Guide.