February 23, 2017 Reading Time: 2 minutes

One important economic topic in the U.S. is the cost of higher education. College is a pathway to economic opportunity for many Americans, but tuition costs cause many Americans to begin their adult lives in debt. Student debt in the U.S. is over $1.3 trillion. In recent years, it has been common for politicians of both major political parties to talk about ways to make college more affordable and debts more manageable. But government subsidies for college costs are a mixed blessing.

One of my favorite studies of this topic is a 2015 New York Federal Reserve staff report by David Lucca, Taylor Nadauld, and Karen Shen. The availability of subsidized federal loans can be good for credit-constrained students, but an increased demand for education may allow colleges to raise prices, partially undoing the effect of the subsidy and making it a transfer to colleges instead of students. The authors look at the variation in the maximum amount of aid available through Pell grants due to legislation changes and at schools with student bodies more or less likely to be affected by these changes. Their method is similar to a technique labor economists use to measure local demand shocks in different cities or regions.

They show that colleges most exposed to changes in subsidized loans raise tuition more. In particular, they “find a pass-through effect on tuition of Pell grants and subsidized direct loans of about 55 and 65 cents on the dollar, respectively.” The real punchline, though, is in the size of the tuition increase. They write, “From a welfare perspective, these estimates suggest that, while one would expect a student aid expansion to benefit recipients, the subsidized loan expansion could have been to their detriment, on net, because of the sizable and offsetting tuition effect.” They also show the biggest winners among colleges are somewhat selective private schools. The authors point out this does not mean that student aid programs are entirely unhelpful, because they provide access to some students who would otherwise not have been able to attend college and higher education is, on average, considered a good investment by most economists, despite high tuition. There may also be spillover benefits to society from a more educated population.

However, this type of analysis is a good warning that we should be careful with programs, however well-intended, that seriously distort the price of education. At best, some of the benefits flow from the government and more-advantaged students to colleges rather than to the intended recipients. At worst, the unintended consequences are large enough that they hardly benefit students at all, leaving private colleges the main beneficiaries while students and their families still pick up the check.

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Patrick Coate, PhD

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