Statement of Dr. Sandy Baum
Professor of Economics
Skidmore College
Saratoga Springs, NY 12866

Committee on Education and the Workforce
Subcommittee on 21^st Century Competitiveness

July 10, 2003

Chairman McKeon, Congressman Kildee, Committee Members:

I am honored to have the opportunity to discuss the vital issue of college costs with you. Let me begin by commending Chairman McKeon and the entire Subcommittee for your focus on college access and affordability. The financial barriers making it impossible for many college-qualified low-income students to continue their education after high school and the difficulties faced by middle-income students in financing college must be reduced. Without progress in this direction, we will be an inefficient economy, failing to use our human resources effectively, and an inequitable society, failing to provide widespread educational and occupational opportunities.

My comments will focus on recent trends in college prices, pointing out both reasons for concern and more positive developments. I am particularly interested in directing attention towards three issues: the importance of grant aid and the net price paid by students; the differences in the circumstances facing students at different income levels; and the potential role for the federal government in providing incentives to states and institutions to improve college access.

There is no doubt that college access and affordability are problems. Tuition at both public and private four-year colleges and universities rose about 40% in inflation-adjusted dollars between 1991 and 2001, while median family income for households with heads between the ages of 45 and 54 grew only 8% in real terms. ¹ Hundreds of thousands of low-income students are unable to enroll in college because of financial constraints and paying for college is a serious concern for most families.

Some additional perspectives are, however, helpful:

-- The tuition increase of the 1990’s was actually a slowdown after the 60% real growth of the 1980’s.¹

-- 38% of four-year college students pay less than $4,000 in tuition and almost 70% pay less than $8,000.¹

Average four-year public tuition grew from 40% of the average income of the poorest 20% of families in 1980 to 63% in 1996, but had declined to 58% by 2002. For middle-income families, the increase was from 12% to 17%, but the 17% figure has been stable since 1992. Improved income growth in the latter part of the 1990s changed the trend. For families in the top fifth of the income distribution, tuition has equaled between 5% and 6% of average income every year for at least thirty years. ¹

--- The actual prices paid by college students have increased much more slowly than the posted tuition prices.

According to the National Center for Education Statistics, while the tuition paid by full-time full-year undergraduates at public research and doctoral institutions rose 20% in real terms between 1992 and 1999, the net tuition (tuition minus grants) rose only 7%. There was no real increase for those in the lowest income quartile. The pattern was similar at other public four-year institutions and net price actually fell in real terms at private non-profit comprehensive and baccalaureate institutions.²

Together, these facts suggest that our concern over college costs should not lead to panic. They serve as reminders that we should focus more on the net price actually paid by students and less on the sticker prices. Students received $90 billion in student aid, including $35 billion in grants and $5 billion in tax credits, to help them pay tuition in 2002-2003. It is, in fact the net price of college – cost of attendance less student aid – which is most relevant to the conversation about college affordability.

These facts also highlight the need for concentrating on access to college for low-income students and appropriately targeting public subsidies. The lower a family is on the income distribution, the greater the problems the rising cost of college presents for them.

What Explains the Rising Tuition Levels?

The fact that we should not respond with panic does not imply that we should be sanguine about the rising price of college. Tuition is among the most rapidly growing components of the Consumer Price Index and its impact on our society is disproportionate to the dollars devoted to it. Why is tuition growth so rapid?

College tuition levels always rise faster than the Consumer Price Index. One major reason for this is the labor-intensive nature of the service being provided. Inflation is an inevitable result of increasing wages unless productivity increases. In the case of higher education, increasing the number of students per faculty member almost always involves a decline in educational quality rather than a meaningful increase in productivity. This explanation does not mean that no cost-cutting efficiencies are possible. Of course they are, and colleges and universities should pursue them vigorously.

It is useful to examine the ways in which the expenditure patterns of colleges have changed over time. Technology requirements, the rising cost of health care, and government regulation all contribute to rising college costs. Both the changing demographics of the student body and changes in the expectations among students about what colleges will provide have increased the cost of student services. But scholarships and fellowships are actually the most rapidly growing component of institutional budgets. At public degree granting institutions, this category went from 2.9% of current-fund expenditures in 1990 to 4.5% in 1999, while instruction, which consists primarily of faculty salaries, grew most slowly, falling from 34% to 31% of the budget. In the private, non-profit sector, scholarships and fellowships constituted 11.4% of current fund expenditures in 1995, up from 9.2% in 1990 and 7.5% in 1985. Total institutional grant dollars more than doubled in inflation-adjusted dollars in the decade from 1991 to 2001.

Almost all students are subsidized in college because even the full sticker price is considerably less than the actual cost of education. State appropriations in the public sector and private contributions in the non-profit sector allow virtually all institutions to charge prices that do not cover their costs. Tuition and fees covered only 13% of public college and university budgets in 1980, but because state appropriations have met less and less of the cost, that figure has risen to almost 20%. For public colleges and universities, where 77% of postsecondary students are enrolled, state appropriations clearly drive tuition. It is easy to see this relationship in announcements from states all across the country over the last few months. In a recent study from the State Higher Education Executive Officers, 17 states reported that reduced state appropriations have led to short-term tuition increases that are inconsistent with their long-term tuition setting philosophies.³ Examination of long-term trends reveals a clear inverse relationship between tuition levels and state appropriations to colleges and universities.

Differences in tuition levels across states are partially due to differences in costs and quality, but philosophical underpinnings also vary. Most states use low-tuition to increase access. Other states have higher tuition and rely on need-based grant aid to increase access for low-income students. The biggest problem with recent changes is not that sticker prices are rising, but that state grants for low-income students are not keeping pace. Hoping to avoid this destructive pattern, New York State recently announced a startling 28% increase in tuition for 2003-2004. But this increase looks quite different when one recognizes that this is the first increase since 1995, and that state grants are being increased, hopefully holding harmless students from families with incomes under $50,000 a year. SUNY faces a 20% decline in appropriations, and even with the planned tuition increase, must cut $36 billion from its operating budget. The policy choice should not be judged just on the annual percentage increase in tuition. Rather, it is the actual cost to students and the quality of the education the university provides that matter most.

Tuition is rising at public institutions across the country not because one state is watching the others and deciding they have an opportunity now to raise tuition, but because state budgets are tight across the country. Tuition is rising at private institutions across the country, not because of any tacit agreement about prices, but because all face the same rising costs and similar declines in revenues from endowments and private giving. They are also compelled to increase their institutional aid budgets in order to increase the pool of students able and willing to pay their prices.

Our system of higher education is characterized by a remarkable amount of diversity. Headlines about the high tuition levels at selective private colleges are disturbingly misleading to the public. Of the 15 million students enrolled in college, about 12 million are in public institutions, and almost half of those attend two-year colleges, where average tuition and fees are under $2,000 a year. According to the College Board, average tuition and fees at four-year private colleges and universities in 2002-2003 were $18,273. This compares to $4,081 at public four-year institutions and $1,735 at public two-year institutions. There is considerable variation even within sectors. Four-year public colleges in New England average $5,484, but in the West, the average is $3,074. There is also a remarkable amount of diversity within sectors. This variation may be one of the explanations for the fact that people tend to significantly over-estimate both the posted price of college and the net price they will be expected to pay.

This price variation also makes our tendency to discuss price increases in percentage terms problematic. The 8% increase in public two-year college tuition levels between 1991 and 2002 amounted to $127. While $127 may be a significant problem for students at the very bottom of the income distribution, it is hard to imagine that it dramatically changes the life choices of middle-income students. The 6% increase for private four-year colleges, on the other hand, amounted to $1000. This warning is important in evaluating the tuition increases now being announced by states, where existing tuition levels vary significantly.

This diversity within higher education is totally compatible with our market economy. Some people choose large urban research universities while others prefer small rural colleges. Some choose occupationally specific programs while others want a broad liberal arts education. Some may wish to pay for elaborate athletic facilities, while others want only basic classrooms. The reality is that there are many people willing and able to pay the prices charged by the most prestigious private colleges. The public agenda should not be to prevent affluent families from paying for this product. It should be, rather, to assure that quality higher education opportunities are available to all who are qualified, regardless of their financial circumstances, and to facilitate choice among available alternatives.

There is no doubt that colleges and universities must find new and better ways to control their costs. The challenge is to accomplish this without significantly reducing the quality of the services being offered. For public institutions, it is important to examine the structure of state appropriation patterns. These systems frequently fail to reward institutions for keeping costs down. But the answer is changing the incentive structure within states, not imposing federal price controls.

It is vital for Congress to be concerned about college affordability. However, it would, in my view, be a serious mistake for Congress to try to control prices in a diverse market consisting primarily of state-run, state-funded institutions and private non-profit institutions, all of which heavily subsidize their "customers." Rather, Congress should provide adequate grant aid to low-income students, create incentives for states and institutions to increase access to college, and allow market forces to direct prices. The recent growth in the role of for-profit colleges is one visible indication of the effectiveness of market forces in this industry. These firms are making significant inroads into the limited areas of higher education in which it is possible to earn profits producing a service efficiently. The non-profit sector will be forced to compete with these market entrants.

Chairman McKeon’s proposal for controlling college costs would punish students for the pricing policies of the institutions on which they are dependent. Perhaps the thought is that no institution would violate the price guidelines because of the severity of the penalty of loss of student aid. But what would happen in states where there simply are not dollars in the budget to fund state colleges to continue their educational mission? Holding the line on tuition would inevitably lead to reduced quality and or reduced capacity. Many students would simply be locked out of the opportunity for higher education. Low- and moderate-income students would be the losers under Chairman McKeon’s proposal. There would be fewer spaces for them and they would be less able to pay for the spaces that are available.

There are alternatives. Given the current level of tuition relative to family incomes, the most important strategy is increasing the amount of aid available to students with very limited resources. Larger aid budgets are important, but more money for need-based aid does not necessarily require larger budgets. The federal government has historically played an important role in encouraging states to provide grants to needy students. The LEAP program (formerly SSIG) provides matching funds for state need-based grants. But that program has stagnated in recent years. States have continued to pour increasing amounts of money into grants for college students, but more and more of those dollars are based on criteria other than need. 26% of state grant aid is now non-need-based and that proportion is growing as more and more states follow Georgia’s lead. There is strong evidence that programs like the Georgia Hope Scholarship program disproportionately aid white and middle- and upper-income students, leaving low-income and minority students in increasingly difficult situations. The federal government can have a significant impact on college access and affordability by designing policies to change the incentive structure facing states.

Similar problems with the distribution of student subsidies exist on the federal and institutional levels. The federal tuition tax credits provide significant help to middle-income students, but have little impact on low-income students. Both public and private institutions are devoting more and more of their aid budgets to competing with other schools for students with high test scores or other qualities, rather than on increasing access to their institutions for students with inadequate financial means. The federal government could provide incentives for schools to enroll low-income students and to provide support programs that improve retention and graduation rates.

The imposition of any form of price controls on colleges and universities is likely to put added strain on their budgets. Credit ratings, on which the cost of borrowing for long-term investments depends, would likely fall. A complex system would require additional bureaucratic costs for compliance and the possibility of losing student aid might necessitate provision for additional institutional scholarship funds.

Generally, price controls are imposed only when an industry has considerable monopoly power. Higher education is clearly not a perfectly competitive industry; there is extensive product differentiation – all institutions are certainly not alike. But there are thousands of institutions and all have strong competitors. It is not surprising that similar institutions have similar prices – price structures are similar and competition reduces price differentials.

Chairman McKeon’s proposal ignores the importance of net price as opposed to sticker price. Given the budget constraints facing higher education institutions and the considerable gap that already exists between the sticker price and the actual cost of providing education, there is no chance that sticker prices will become affordable for the majority of students. We must and should continue to rely on need-based grant aid to allow students with different levels of financial resources to pay different net prices. Under the Chairman’s proposal, an institution that held its tuition down by eliminating need-based grant aid would fare much better than one that raised tuition in order to lower net price for the majority of its students. The same would apply at the state level. A state that opted for a slightly higher increase in tuition in order to increase the amount of state grant funding for low-income students would be penalized, while a state that took appropriations from its grant funds in order to reduce tuition for all students would benefit. But the latter state would end up closing the door on low-income students. Surely this is not the intention of Congress.

The goal of Congress, like the goal of state governments and educational institutions, should be to provide access to high quality education and the opportunity for success to as many students as possible, regardless of their financial circumstances. Given the limited resources available for this endeavor, the only option is to ask those who can afford to pay to bear a reasonable portion of the cost of their education and to target subsidies on those with more limited resources. We should also work to simplify the student aid system and to make it more transparent to students, publicizing clearly both the importance of a college education and the extensive opportunities and subsidies that are available to students.

I would like to thank all of the members of the Subcommittee for giving me the opportunity to present these comments.