Understanding Tuition Inflation: Causes & Future Trends

The general expectation once students graduate High School is that they go on to get some kind of higher education or attend a trade school in their area of interest. Broadly speaking, this still makes sense. Future earnings potential, quality of employment, and probability of staying employed all increase once you get another diploma. Yet, for students seeking a degree at four-year college or university, the cost of tuition has become too high for some to even consider it, leaving many people wondering how did college get so expensive?  

The reasons for the high sticker prices on tuition are mixed, complicated, and persistent. In the sections below we explore the historical context for tuition inflation, we break down the economic concepts of what’s involved, and we evaluate the different sources that have been claimed to be the cause, as well as some of the factors that will affect how much college will cost in the future.

Historical Preview

Tuition prices have been increasing since the late 1980’s. The rising costs of higher education inputs, flat returns on college endowment funds, spendthrift schools and decreases in government funding are all perceived offenders.

There is at least some truth to all these points, but a cursory analysis runs the risk of being misleading. That is why it’s important to dig deep, and try to find the true forces that have pushed tuition to such high levels.

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Tuition prices have gone up at a much faster rate than other goods and services over the past three decades. For public institutions alone, in-state tuition and fees “between 2007-08 and 2017-18,… increased at an average rate of 3.2% per year beyond inflation,” and at 4.0% and 4.4% for the two decades before that. The story is much worse for private non-profit schools who have seen their tuitions grow at alarming rates to unreasonable levels [see graph below].

SOURCE: College Board, Annual Survey of Colleges.

 

i) Easy Access To Credit

There is no way to divorce trends in higher education from those of the general economy. The Federal Funds Rate, which indirectly dictates the interest rates at which banks lend to their customers, has followed an inverse relation relative to tuition prices since the 1980’s- as the federal rate has gone down, tuition has gone up.

Source: Board of Governors of the Federal Reserve System (US)

Though a causal effect is difficult to prove, the relationship makes sense. As credit becomes cheaper, banks are able to loan out larger sums at lower rates. This has given students, who tend to have low credit scores, access to larger amounts of immediate cash, especially if they have a cosigner. Given the greater access to funds, schools raise tuition on their students because they can now “afford it”.

Similarly, the relationship between direct federal loans and grants, and tuition prices, follows that same logic. Known as the “Bennett Hypothesis”, after Ronald Reagan’s secretary of education, William Bennett, the hypothesis holds that the more government loans and grants are given to individual students, the more tuition will rise.

A 2015 study by the New York Federal Reserve seems to support that claim. It found that “tuition effects of changes in… [the maximum aid students can receive from a given government program] are about 60 cents on the dollar for subsidized loans and 15 cents on the dollar for unsubsidized loans”.

Tread carefully though, that is just one study and conclusive evidence of a causal relationship is still debated; just because two things move in the same direction does not mean one caused the other to do so, and proving so is very difficult.

Nevertheless, the hypothesis and study point to an ominous conclusion that greedy colleges will marginally raise their prices based on changes to student aid availability. In other words, the more money available to students from the government (and banks), the more schools will push their tuition prices.

Cost Push

There are other more direct sources of tuition inflation. When it comes to the things that have made cost-per-student at universities rise for example, the interaction between enrollment demand, institutional aid, and tuition can be traced to identify pressure points.

Further, there are indexes and metrics constructed specifically to track how much it costs to run a university; we will evaluate them as well and try to gauge their advantages, shortcomings, and impact on the discourse surrounding tuition costs.

i)  HEPI vs. CPI: Contrasting Consumer Price Index Increase and Higher Education Price Index Increases

One of the most cited reasons behind the steep rise in tuition prices over the past few decades is the ballooning price of higher education inputs relative to other goods and services. In other words, it’s more expensive to run a school now than before.

Universities don’t spend money on the same things people do. Their budgets allocate funds between faculty salaries, employee benefits, supplies, and things of the sort- individuals on the other hand spend it on groceries, subway passes, and haircuts.

Consumer price changes are calculated by the CPI (Consumer Price Index), which measures how much prices in the economy change over a given year based on a basket of goods and services consumed by the average person- otherwise known as general economic inflation.

HEPI  or “Higher Education Price Index” on the other hand, measures the price change of things universities need to keep on running (like service salaries, clerical salaries and utilities). When people cite the rising costs of college inputs, that’s what they mean. Why is college tuition so high? Well administrators, professors, janitors, and gardeners get paid more money.

Source: Commonfund Institute — 2014 hepi update

Still, the HEPI is often overestimated as a reason for rising tuition costs. That’s because if you don’t take into account that other goods and services, like the ones included in the CPI, went up as well, you’ll end up getting a distorted view of how much college inputs actually impact tuition. This lets other things that have pushed tuition up off the hook.

It’s also important to note that the HEPI is self-referential- it goes up and down depending on the decisions made by the people who reference it. We have little bearing on the cost of what we buy on a daily basis, university executives on the other hand can to a large extent choose how much they pay their employees (and themselves!).

ii) Demand for College Education, and Institutional Aid.

Universities have changed a lot in the past few decades. As demand for higher education has increased, more and more students are trying to get into high quality schools. In response to the growing demand, many big institutions have devoted considerable funds toward fancy rec centers, research programs, and student service centers.

In this flurry for talent, they have raked up enormous debts they can’t seem to handle. Instead of cutting back on spending, they often transfer the cost of these projects onto their students through tuition. As most don’t have the money to pay the hefty sums either, they themselves take on debt. It’s a vicious cycle and an important reason for the longstanding rise in tuition inflation over the past years.

There are also other strategies colleges have used to better appeal to the best and brightest. Institutional aid (that is, money given by a college or university as opposed to the government or someone else) has become one of the most effective ways schools attract applicants and prospective students.

This type of grant aid (free money) increased by 32% over the past 5 years to $58.7 billion. Over the same period, “federal grant aid declined and grant aid from states, employers, and other private sources increased by less than 10%.” (College Board, 2018).

Source: College Board, Figures & Tables- 2017

As school-provided aid increases, and cost-per-student stays the same (or increases as well), a smaller number of students are made to pay their portion of the school’s expenses and debt. So it’s not the universities giving money to the students per-se, it’s students who receive little to no institutional aid paying for their peers’ share of the pie.

There is an important note to take into account though: institutional aid is almost exclusively predicated on need and merit, so if some students receive more money from their school than others, it probably means they were more qualified to receive that assistance in the first place.

Revenue Pull

The pressure on tuition has not only come from the rising costs to run a university, but also from a decrease in the money they would get other than tuition. Returns on endowment and funding by state governments are two major sources which have been faltering as of late. The gap left by them has forced schools to look for funds elsewhere, and students have often proven to be an easy fix.

i) Revenue Pull of Public Funding

Public funding (or lack thereof) is one of the most cited villains allegedly pushing tuition hikes at public universities. There are two major categories of public financing: loans and grants, which were already discussed in the form of the Bennett Hypothesis, and “student appropriations” which is aid transferred directly to schools and given on a per-student basis.

The “Disinvestment Hypothesis” describes the relationship between disinvestment in state funding through student appropriations, and tuition rates. It holds that there is a positive causal relationship between them- increases in disinvestment will cause an increase in tuition prices.

It deduces that if states devote less money per-student to their institutions of higher learning, those institutions will fill the gap left by that influx reduction with tuition revenue.

A 2014 study by researchers at George Washington and Sungkyunkwan University, concluded, in accordance with other research, that “just ten cents of every dollar increase in appropriations would find their way into lower tuition”- meaning that if state funding increased by $100 per student, tuition would only be expected to decrease $10. Therefore the marginal effect of state funding on tuition is minimal and thus an ineffective way of curbing tuition prices at public universities.

That being said, it’s important to understand that the relationship is not straight-forward, and many smart opinions exist on the matter. Still, it illuminates the fact that pointing to the government and demanding more money for schools may not be the answer to its rising costs.

Source: The Impacts of State Control Policies on College Tuition Increase- 2015

ii) Endowment Investment Return Tightening

Universities have other important sources of income besides state funding (for public schools) and tuition revenue. Many rely heavily on private donations from alumni and others to build their endowment funds. They use these funds as capital to invest and generate returns for the university. They then reinvest those returns, or allocate the money to building projects and their annual budgets.

In a study that looked at 809 institutions of higher learning, the 10 year-average return on endowments as of 2018 was a low 4.6%, while average effective endowment spending rates (how much endowment money the school spent) sat at 4.4% for all universities, and 4.8% for those with funds over $1 billion. That means that on average, universities barely broke even, and rich schools did even worse.

With endowment investment returns tightening, schools are forced to look at other revenue streams to pay for their growing costs- they often turn to the students to foot the bills.

However, in contrast to the majority of reasons cited in this article, endowment returns are an exogenous revenue stream- besides employing better investment managers, the universities are quite plainly at the mercy of the economy and financial markets.

Current Trends

Despite all the doubt and headache the word “college tuition” may evoke, things seem to be changing for the better. Net-tuition rose at the same pace as economic inflation in 2017, and total enrollment decreased, which generated downward pressure on tuition hikes (less demand, same supply equals a price decrease).

To be clear, tuition is still going up, what’s subsiding is the rate at which universities raise their prices. College is still crazy expensive, it may however stay at the same level of crazy for the foreseeable future.

Also, the Truth-In-Tuition Act, a pending bill in the House of Representatives, would seek to increase the transparency of university cost for students and their families. The bill “would require schools to present each incoming class with a multi-year tuition and fee schedule or give each student a non-binding estimate of what their education will cost them individually.”

Public schools will still have the power to change tuition as they see fit, but they will have to be much more forthright about their intentions to do so. The idea is that universities will be more cautious in how much they raise tuition if they have to forewarn students about those increases 4 years in advance.

Another set of developments worth looking into is President Trump’s changes to the Department of Education, which oversees federal financial aid programs. His proposed budget for the Department is sure to rock the boat. How the changes affect each person depend on their specific situation. If students are planning on using federal programs to help pay for college, they must find out how incoming changes affect their future aid availability and tuition prices at their schools.

Conclusion

Tuition inflation is a difficult topic to grasp. It’s easy to blame politicians and university presidents for the ballooning costs and crippling debt foisted on university student, and they definitely deserve a lot of the responsibility. The reality of the situation, however, is more involved.

School presidents wouldn’t raise prices so much if there weren’t such pressure from competition, enrollment demand, and increases in HEPI that kept inflating their budgets. The government can only subsidize public schools and students so much, its in deep debt itself and already shelling out for a lot of the cost.

Further, as previously examined, the relationship between government funds and tuition is not so straight forward. The graphic below illustrates some of the factors and their relationships:

In reality, the strings must be tightened from all sides; schools have to curb spending, government programs should be more effective and comprehensible for students, and fiscal transparency from the universities must be demanded.

Yet, for now, the cost will remain astronomical, so it’s important to prepare as well as possible for the financial burden college will inflict. Taking the time to find the right aid and plan out your finances is key to a successful bout through the ring of public education.

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