Student Loans Might Be Driving Up the Cost of College. So What Do We Do About It?

Yeah, this photo from a 2012 Occupy protest is a little dated. But better than another picture of a college campus.


In 1987, President Reagan’s secretary of education, Bill Bennett, published a now classic New York Times op-ed titled “Our Greedy Colleges” in which he argued that the government’s attempts to make higher education more accessible may have also accidentally made it more expensive. “If anything,” he wrote, “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.” Ever since then, academics have sparred over whether the so-called Bennett hypothesis is really true. Do colleges actually take advantage of all those federal grants and loans by hiking their prices? And if so, are some schools even more callous about it than others? 

Economists have delivered inconsistent answers to those questions over the years. (I reviewed the research back in 2012 while Vox’s Libby Nelson published a great, updated rundown in August). But it’s always seemed possible that Bennett’s idea contained at least a grain of truth.

Earlier this summer, a team from the Federal Reserve Bank of New York and Brigham Young University released the latest paper suggesting that, indeed, the man was right. Looking at both public and private nonprofit colleges during the mid-2000s, they found that schools raised tuition by 55 cents for each $1 increase in Pell grants their undergraduates received, and by 60 to 70 cents for each extra dollar of subsidized student loans. Some schools seemed more eager than others to raise their prices when the government made more aid available, the worst offenders being private colleges with high tuition and high admission rates—what you might call schools for unexceptional rich kids.

Why would this happen? As the Roosevelt Institute’s Mike Konczal points out, the answer is a little less obvious than you might assume—in a world of rational econo-bots, people aren’t supposed to willingly pay more for an investment, such as a college degree, just because they can get a loan for it.* But the reality is that there are still lots of 18-year-olds who will pay more or less whatever it takes to attend the college of their choice so long as they can find the cash. By letting students borrow more, the government may just be inviting schools to raise tuition, knowing kids simply respond by taking on extra debt.

This latest study probably won’t be the final word on the subject. Certainly, it leaves some important questions unanswered. For instance, while the paper tells us how much colleges increase the prices they advertise when loan limits rise, it doesn’t say how much more students actually end up paying. That’s a crucial distinction. At private colleges, more than half of undergraduates pay less than full tuition. And according to one analysis, for every $1 that private institutions raised their sticker prices from 1999 to 2010, they increased their aid budgets by an average of 60 cents. So, to some extent, we may be talking about phantom tuition hikes.

But let’s say the New York Fed is right, and the Bennett hypothesis is true—that federal loans and grants aid have helped fuel runaway tuition inflation. What, exactly, does that mean for policy?

For starters, it may be a problem for conservatives, who have argued that the key to fixing higher education is to loosen accreditation standards, so that students who attend low-cost online programs can become eligible for federal aid and compete with traditional institutions. But if the Bennett hypothesis holds, then we should expect many of those programs to raise their prices the second their students are allowed to start borrowing Stafford loans and applying for Pell grants. That, by the way, seems to be precisely what has happened in the for-profit industry, where accredited schools with access to federal aid charge 75 percent more than substantively similar unaccredited programs.

What about nixing the federal student loan program entirely, or at least limiting it a bit? That also might not be such a hot idea. First, it’s important to realize that even if federal aid leads to somewhat higher prices at Lavish Private U With Lax Academic Standards—or State U for that matter—in the end it still probably increases access to education. Without Washington’s help, some students wouldn’t be able to borrow whatsoever, or would be forced to pay far higher interest for private loans, which could keep them from attending college at all.

It’s also not exactly clear what getting Washington out of the education loan business would accomplish, since the move wouldn’t kill off student lending so much as abandon it to the private sector. Some would argue that’s a good thing, because unlike the federal government, which will lend to anybody, banks have underwriting standards, which theoretically keep them from extending credit to students who are unlikely to be able to pay it back. But those standards have sometimes proved to be pretty loose in the past, and frankly, risky, lower-income students aren’t the sort of undergrads whose infinite willingness to shell out for the school of their dreams is helping drive up tuition. Meanwhile, a lot of the expensive, private schools that seem most likely to raise their prices when loan limits increase cater to the types of undergrads that probably won’t have much trouble getting credit from Wells Fargo or Sallie Mae. Even if the feds pull back, a lot of loans are still going to flow.

So what to do? Like Konczal, I tend to think that if student loans and grants really are driving up tuition, it means the best option is to refund our public higher-education system while requiring schools that take the cash to lower their prices, which should create market pressure for private colleges to do the same. As it happens, this is quickly becoming the consensus position among Democrats, embraced by Hillary Clinton and Bernie Sanders (I’ve written on the subject here, here, here, and here). If we’re going to hand out money to colleges, the government needs to attach a few strings. That might not be the answer Bennett himself would prefer, but at this point, it seems the most reasonable.

*Correction, Sept. 8, 2015: This post originally misspelled Mike Konczal’s last name.