The Case Against Tuition-Free Higher Education

2015-11-25-1448433091-9487641-berniesanders3

Millennials, blue collar workers, and grassroots organizers across the United States have galvanized around Bernie Sanders’ message of taking big money out of politics, redoubling efforts to end income inequality, and making health care a right for every citizen.

Indeed, many Americans agree with Bernie’s positions, which resonate deeply with the ideal that our society should be both free and just. The ideological quality of those viewpoints notwithstanding, some of the policy proposals put forth by Bernie’s campaign to achieve those goals are either unfeasible or would ultimately prove ineffective.

In the case of Bernie’s call to make public colleges and universities tuition-free, his plan is unlikely to implemented uniformly across the US, decreasing its intended objective from the outset, and, even if it successfully enacted, low-income students would still not receive the full benefit of an affordable college education.

Note that much of this analysis has been adapted from my final project for my Public Economics class at Wesleyan University.

The Back Story

Sanders introduced S.1373, the College for All Act, to the Senate Floor soon after announcing his candidacy for President. The bill outlines several measures to make higher education in the United States more affordable. The most well known proposal: eliminating tuition at public colleges and universities.

In the course of Bernie’s campaign, both sides of the aisle have expressed skepticism over the necessity of further government involvement in higher education and the massive increases in spending needed to make college tuition-free.

Objectively, there are several conditions present in the market for higher education that may indeed merit the expanded role of government proposed in Bernie’s plan.

Among public economists, the framework for government intervention in the economy centers on the presence of deadweight loss, in which mutually beneficial trades are prevented from occurring. When those transactions do not materialize, society cannot reach a competitive equilibrium and efficiency cannot be maximized. Economists term this condition a market failure.

Let’s put that into English:

There’s a farmer who has carrots that I would like to buy. She sets them at a reasonable price I can afford. Done deal, right?

asylum_township

Well, here’s the issue: the farmer lives on the other side of a large river. I’m talking massive. Full of whitewater rapids and piranhas. Don’t let that idyllic picture fool you. This is not the place you would go canoeing, tubing, or swimming.

Suffice it to say, there’s no chance in hell I’m crossing that river. So, that mutually beneficial transaction never happens. I’m left wanting carrots (and have developed a phobia of water) while the farmer is forced to bake a dozen carrots cakes before her produce rots. A lá deadweight loss.

Efficiency, as measured by how adequately resources are distributed to serve everyone’s needs, is not maximized in this situation. Resources can be redistributed through a mutually beneficial trade between me and the farmer, but aren’t.

Let’s say this happened on a broader scale, such that there are several farms next to the river and a thousand more Freds who want their beta-carotene. Now we have a market failure on our hands, which is grounds for government involvement under the above framework.

In this instance, the government might construct a bridge to the coastal farms or go about removing piranhas from the river. If all the beneficial trades that were prevented from happening earlier do indeed occur, then society will reach a competitive equilibrium as a result of the government’s actions.

Caveats:

1) For smaller market failures, the government shouldn’t always intervene. The cost of taxpayer dollars and human resources may outweigh the benefits of a competitive equilibrium in society.

2) Government involvement can also be the source of deadweight loss through its direct and indirect effects on supply and demand that result in unrealized transactions.

3) The noted costs and the losses in efficiency from government intervention might be deemed acceptable if those actions improve equity in society.

In the market for higher education, we can think of equity as uniform access to a college education, but more on that later.

The Credit Market for Higher Education

Within the market for higher education, there are several market failures. Perhaps the most well-known is the presence of credit market failures, in which students can’t attain their desired level of education due to a lack of available funds. Social efficiency isn’t maximized because those students can’t achieve a more productive outcome.

Fitness Tracker Company Fitbit Debuts As Public Company On NYSE
Celebration at Fitbit’s IPO at the New York Stock Exchange.

Unlike businesses, students cannot finance their education on equity, which involves the sale of shares of ownership. (In the marketplace, we see equity financing most with initial public offerings (IPOs) from businesses and corporations. Example.)

So, students instead have to obtain funds for education through debt.

Few financial institutions, however, will readily make those funds available to students for two main reasons:

1) Those institutions cannot easily determine which students will repay the loans due to meager or non-existent credit history

2) Students lack the collateral that would be collected upon default of the loan. At best, students have a car, the valuation of which could greatly vary.

In effect, the demand for funds to cover tuition costs is far higher than the supply, a function of the lender’s willingness to provide loans. Mutually beneficial transactions that could occur between student borrowers and financial institutions don’t happen, prompting the presence of deadweight loss.

In this instance, the best suited government involvement would expand access to funds among students in order to finance their college attendance. With the creation of the Stafford loan program in the Higher Education Act of 1965, the federal government did just that.

7fb9bdd9e7a2ecf13c805c9a0909d733x

Note that government officials are no more adept at determining which students are going to repay their loans. However, through enormous interest payments, the Stafford loan program actually makes a profit for the Uncle Sam. Bernie’s campaign estimates this amount to be $110 billion annually (Bernie 2016, 2016).

In addition to increased accessibility, repayment of student loans is deferred while the student is enrolled in college and interest rates for these government loans are subsidized based on the individual’s family income (Avery and Turner, 2012).

Low-income students are also eligible for non-repayable Pell Grants, which in the 2016-2017 school year will provide up to $5,815. These efforts have done much to increase access to the necessary financial tools to fund college attendance, attenuating the education credit market failure.

One could also argue that the federal government could decrease those interest rates further to make college education more accessible. Indeed, this is a key provision in Bernie’s College for Act all.

Currently, direct subsidized and unsubsidized loans from the government come with a 4.29% interest rate. (The unsubsidized loans used to come with a higher interest rate.) Bernie proposes decreasing the interest rate to 2.37%, which might help with affordability, but not with access. Again, more on that later.

Many on the left will be quick to point out that one can take out a mortgage or an auto loan at a very low interest rate (~3.0%).

Keep in mind, however, that students do not have the benefit of a steep credit history or the collateral of a house or a vehicle that can be collected upon default (confiscating a piece of paper with old English script doesn’t cut it).

A Family’s Inability to Maximize Efficiency: Selfish Parents

Okay, this is where the getting gets good.

There’s another important market failure in higher education beyond the inability of private financial institutions to provide adequate funds for college tuition. Though a college degree often confers economic benefits to a family in the form of a higher standard of living, parents might forego maximizing the efficiency of their children by refusing to invest in their higher education.

Indeed, research backs this up. A landmark study by Lundberg, Pollack, and Wales (1997) found that expenditures made on behalf of children increased substantially when control over monetary resources shifted from husbands to wives. This finding suggests that parents in nuclear, heteronormative family structures tend to underinvest in the utility and efficiency of their offspring.

scu7e91
The Trump family clearly didn’t suffer from this market failure…

In the market for higher education, parents could withhold funds from their children to pay for the costs of of tuition or provide resources for interest payments on student loans (Gruber, 2013, pp. 295-296). Even though these parents are fully aware of the potential benefits from college education and the financial instruments available to help finance that attendance, they refuse to decrease their current level of consumption.

For ease, we can term this market failure “selfish parents”. The beneficial transaction between institutions of higher education and potential college students doesn’t occur, preventing a socially optimal outcome.

Here, the most appropriate form of government involvement is likely the public provision of higher education as opposed to increasing access to financial tools through student loan programs or lowering the interest rate on those loans.

Indeed, this is already the main role that government plays in in the sphere of higher education: there are thousands of local and state colleges and universities.

In the 2012-2013 school year, expenditures at public institutions were about $311 billion, compared to $116 billion at private, non-profit schools (National Center for Education Statistics, 2015). Much of these funds helps to subsidize the cost of tuition. The average cost of in-state tuition at public institutions was $9,410 during the 2015-2016 school year (The College Board, 2016a), compared to $43,290 at a private intuition (The College Board, 2016b).

free-community-college-cartoon

One might ask why public institutions of higher education even have tuition when primary and secondary public education is “free” (obviously the government funds it through taxpayer dollars). For that, let’s do a quick history lesson.

Public Provision of Education

The public provision of tuition-free primary and secondary education is driven by the presence of what are called “positive externalities”. We can think of these as spillover benefits for an individual or society as a whole.

A classic example of a positive externality is your anti-social neighbor’s garden. Every time you venture outside of your house, you enjoy the sights and the smells of the fresh peonies and lilacs. You eventually elicit so much joy from the garden that you offer to help spread mulch or water the flowers. But your neighbor, ever the introvert, instead shoos you away and shouts at you in what you think is Vietnamese.

mmd_jc-nguyen-2
“Stay the hell away from my hydrangeas!”

So, the garden boosts your utility even though you contributed no resources whatsoever to bringing about its existence. This is the basis for a positive externality. (There are also negative externalities, which are explored here.)

With primary and secondary education, the spillover benefits have been well-documented:

1) By obtaining a basic level of education, an individual becomes much more productive and increases their standard of living, in turn benefitting society through economic growth and the increased collection of taxes (Card, 1999).

2) The attainment of basic education is a key component in creating and maintaining a democracy, as first theorized by Aristotle (Lipset, 1959).

3)  A well-educated citizenry also reduces crime (Lochner, 2004) and increases health and well-being (Oreopoulos, 2006), both of which carry significant social benefit through less government spending on law enforcement and lower healthcare costs.

All of this stuff is great, but we have to keep in mind the justification for government intervention: the presence of a market failure.

The deal with most positive externalities is that they’re under-produced, a result that is somewhat intuitive. A great deal of people benefit from the good, but there’s no driving force for the supply to meet that demand.

In the above example, my neighbors down the street would also elicit joy from all those daffodils, but cannot because the supply of the garden (as measured by the plot of land on which the flowers are planted) is not large enough. Thus, a beneficial “trade” cannot occur, spurring deadweight loss.

It should also be mentioned that there is even more of a credit market failure for primary and secondary education. If financial institutions aren’t willing to loan funds to a college student, you can be sure they won’t give thousands of dollars to a toddler to pay for kindergarten.

kindergartenThus, due to the presence of immense spillover benefits and the education credit market failure, the government intervenes by providing tuition-free primary and secondary education, which have very high uptake. In the 2010-2011 school year, for instance, 90% of elementary-aged students were enrolled at a public school (National Center for Education Statistics, 2014).

While there is a certainly a further increase in productivity from the attainment of post-secondary education, the spillover benefits listed above that justify the public provision of “free” primary and secondary education drop off precipitously for college attendance (Lochner, 2011).

Put another way, the same factors that prompt government to eliminate tuition at primary and secondary schools do not justify tuition-free higher education.

Therefore, while the presence of “selfish parents” does merit the existence of public colleges and universities, that market failure alone cannot justify making higher education free.

A Family’s Inability to Maximize Efficiency: Information Problem

There is one important assumption made in this “selfish parents” framework, however; parents are aware of the potential economic benefits from a college education, which may outweigh their monetary investment. That isn’t always the case.

Recent research that explores differences between low-income families and their wealthier peers shows a wide divergence in the perceived advantages of attending college.

While individuals from well-off backgrounds had an “unspoken confidence that their time in higher education would be financially worthwhile,” students from low-income backgrounds were fixated on the financial risk of a college education in addition to the opportunity cost of forgoing multiple years of income (Christie and Monro, 2010).

The presence of debt aversion among low-income and first generation college students has also been well-documented (Burdman, 2005; Pennell and West, 2005). This phenomenon has been attributed to students’ “limited knowledge of and family history with student loans,” that may prevent them from seeking out the existing public financial resources to attend an institution of higher education (Somers et al., 2004).

Compared to debt-tolerant individuals, who usually come from a higher-income background, debt-averse students are five times less likely to attend an institution of higher education (Callendar and Jackson, 2005).

So, in light of this debt aversion, it might make sense to remove all debt by making college education tuition-free, especially if those most affected would be low-income and first generation college students.

Indeed, there is evidence for the negative selection hypothesis, as first proposed by Brand and Xie (2010). The theory holds that students who are the least likely to obtain a college education are simultaneously the ones who would benefit the most from that attainment, as measured in higher incomes.

Perfect! We simply remove all financial barriers, thereby allowing low-income students to easily attend college and society to reap the benefits!

tumblr_nqf85bbd2y1qb1uhko1_500

But not so fast. Other research shows that college attendance among students from low-income backgrounds doesn’t always hinge on the presence of financial barriers or sources of funding.

Crowd Out

Carneiro and Heckman (2002) found that long-term factors, such as family socioeconomic background, were more central to college attendance than short term credit constraints. This finding held true even “in many different environments including those with free tuition and no restrictions on college entry.”

Similarly, Dynarski (2002) showed that increasing loan eligibility for low-income students did not significantly increase college attendance rates. Thus, the mere availability of funds through the Stafford loan program, subsidization of student loan interest rates, or even the complete elimination of tuition might not spur increases in education attainment among these debt-averse individuals.

For the sake of argument, let’s ignore these findings and assume that eliminating tuition will automatically make low-income and first-generation students more willing to attend college. If they were the only ones for whom college would be free, that increased attendance is a safe assumption to make. However, there is still a high risk of what’s known in economics as “crowd out”.

Broadly removing tuition from public higher education might also lead relatively wealthier individuals who attend private institutions to switch to public colleges and universities, crowding-out lower-income students and preventing them from fully capturing the benefits of a college education.

hbcu

On the flip side, smaller, private institutions, such as historically black colleges and universities (HBCUs), would also face decreased enrollment rates. South Carolina Representative Jim Clyburn notes that HBCUs may be unintentionally defunded by the crowd-out effects resulting from Sanders’ plan (Young, 2015).

As 20% of African-Americans who hold a Bachelor’s degree earned it from an HBCU, the College for All Act could also have severe impacts on equity by increasing the race gap in higher education attainment. Already, only 21% of blacks earn a degree within six years of attendance at an undergraduate institution, compared to 42% of whites (National Center for Education Statistics, 2006).

Such crowd-out would thus substantially limit the stated goal of Sanders’ policy to increase college attendance among those who currently do not attain such education due to financial want. To be certain, higher education would be made more affordable, but mainly for those who are already attending college.

A landmark study by Dynarski (2000) examined the effects of Georgia’s HOPE scholarship, which provided free attendance at state colleges for middle- and high-income students earning at least a B average in their high school courses. She found that for every additional $1,000 in subsidy, college attendance among students in those groups increased 3.7 to 4.2 percentage points, which widened the gap in college attendance between low-income and high-income families.

With the elimination of all tuition costs, a similar trend might be observed at public institutions throughout the United States.

From an international perspective, there is further evidence to suggest removing all financial barriers from public higher education could spur crowd-out. Gonzalez and Menendez (2002) found that 90% of students in tuition-free public colleges and universities in Argentina came from families with an income that was higher than median.

The authors concluded that the public provision of education in this manner was an “implicit transfer to the richest individuals in the society,” in which eliminating tuition fees decreased both equity as well as efficiency, as lower-income students were prevented from achieving optimal education attainment.

While there are myriad factors in both the United States and Argentina that influence college attendance among low-income students, these findings are nonetheless sobering and point to the potential negative impact on equity from crowd-out.

~

Let us return to the source of this debt aversion: a lack of awareness of available financial tools and of the economic benefits posed by a college education. Any attempts to alter the existing financial barriers to college education without addressing this information problem are almost sure to fail in increasing attendance among low-income students.

Thus, the best-suited government intervention to address the market failure (a family’s inability to maximize efficiency) that results from this information problem is a more robust program that targets the incidence of misperceptions and misinformation.

themba_and_jill

This program may include an expansion of college counselors in low-income school districts, who may begin to circulate information about college costs, the availability of financial aid packages and student loans, and the advantages of a college education as early as middle school.

Additionally, measures would be taken in this program to ensure this information also reached the families of students through informational events during the evening and educational newsletters.

Such efforts would work to ameliorate the persistent debt aversion, potentially leading to an increase in college attendance among these individuals and providing the best chance for the government to increase efficiency in society, while forgoing massive increases in spending and involvement in higher education.

~

To recap, market conditions don’t prescribe broadly removing tuition at public colleges and universities and while the policy would make college more affordable, it wouldn’t necessarily increase rates of attendance among low-income students because of two key reasons:

a) it fails to address the inherent information problem that restricts many low-income students from attending college;

and

b) it would be unable to counteract crowd-out from wealthier individuals switching to public institutions

And we’re just getting started.

The Infeasibility of Bernie’s Plan

The elimination of tuition at public institutions of higher education is estimated by Bernie’s campaign to cost $75 billion on an annual basis (Bernie 2016, 2016). Obviously, that’s a ton of money.

Wall StreetTo raise this revenue, Bernie proposes a new tax on Wall Street speculation, in which stock trades are taxed at 0.5% and bonds trades are taxed at 0.1%, would be implemented. Based on his campaign’s estimates, these funds would completely cover the federal portion of eliminating tuition at public institutions.

Economists, however, disagree on the efficacy of this tax. While the Policy Economic Research Institute at the University of Massachusetts, Amherst calculates the tax will raise as much as $340 billion annually over the next decade (Pollin et al., 2016, pp. 1-4), the Tax Policy Center estimates that only $50-60 billion a year would be collected (Sammartino et al., 2016).

The large variance here results from the unknowable and potentially adverse effect of taxing trading on Wall Street. Higher transaction costs might cause firms to conduct fewer trades, lessening the amount of collected tax revenue as well as decreasing investment in several economic sectors. In turn, these more negative effects would impact efficiency and potentially negate the economic benefits that could result from a more educated society.

Moreover, the effects of crowd-out could also increase the overall cost of the policy and thereby distort estimates of tuition fees at institutions of higher education.

Dynarski (2000) observed that the HOPE scholarship had an inflationary effect on the cost of college attendance in Georgia, outpacing the rest of the U.S. by as much as 13 percentage points in some years. In fact, when a national HOPE scholarship was being considered, the state legislature of California considered increasing tuition to allow more students to qualify (Basinger and Healy, 1998).

Whatever revenue is ultimately raised by the federal government’s tax on Wall Street would be provided to states as a 2:1 matching grant (Sanders, 2015). This means that state governments would have to front about 33% of the bill to eliminate tuition at their home institutions.

These states would need to move around funds or find new sources of revenue, which could result in increasing existing taxes or the formation of new taxation measures. Depending on who bears the economic incidence, these additional measures might have significant impacts on supply and demand in certain markets, further diminishing efficiency and creating deadweight loss.

Beyond these adverse impacts, there is much reason to believe that states would not readily adopt the policy.

Historically, Republican-led states have been hesitant to enact provisions similar to those that would be necessary to eliminate tuition. The attempted expansion in Medicaid as part of the Affordable Care Act (ACA), which required states to provide 10% of the funding after the first three years of the program during which time the federal government provided the entirety of the bill, suggests there might be significant limitations to the implementation of this plan as only 31 states obliged (Kaiser Family Foundation, 2016).

current-status-of-the-medicaid-expansion-decisions-healthreform3

All but one of the 19 states that have not adopted the new ACA provisions is led by a Republican governor, most of whom cited the expansion of Medicaid as an unnecessary increase in spending. Thus, it is unlikely that Republican-led states would comply, restraining the reach of Sanders’ plan.

Moreover, while state governments can be sure that the individuals who would receive the benefit of increased Medicaid coverage will remain in the state, the same cannot be said for in-state attendees of public universities.

Unless the government stipulates that residents must continue to reside in the state following graduation from a tuition-free institution, there is no guarantee that the gains in productivity and efficiency from that student’s degree will directly benefit the state. In effect, the return on investment might be zero in many cases.

Further, the proposed tax on Wall Street speculation might also be difficult to implement because of the undue influence of financial institutions and investment banks on legislators in Washington, which Bernie has been quick to point out.

It is not inconceivable that those firms would attempt to lobby law-makers to vote against the tax, as it would substantially increase the transaction costs associated with trading.

Summary

If you skimmed through the above babble, here are the main takeaways:

  1. Market conditions indeed permit the public provision of higher education as per the established framework for government intervention.
  2. Market conditions do not justify eliminating tuition at public colleges and universities.
  3. There is reason to suggest that such a policy would be ineffective at increasing attendance among low-income students, though it would certainly make college education more affordable.
  4. Given the provisions outlined in Bernie’s plan and the current political landscape, the policy is unlikely to be uniformed implemented as it is.

1 Comment

  1. Interesting, understandable and well written & researched about a complex issue(s). Clarified what was bothering about this plan of Bernie’s.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s