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In the Nation's Interest

Should College Be “Loan Free”?  Assessing the New College Compact – Part 1

College affordability is fast becoming a major issue in the 2016 election.  Tuition at 2- and 4-year institutions has been outpacing inflation for decades – rising over 3 times faster than the Consumer Price Index since the 1980s.  Meanwhile young people (and their parents) repeatedly hear – for the most part correctly – that at least some postsecondary education is necessary to obtain a well-paying job.  Put those factors together and you have student loan balances of $25,000 when averaged across all Americans who hold such debt and even higher balances – approaching $30,000 – for the recently graduated college class of 2015.  Many speculate that these debt burdens are causing Millennials (and others) to limit their spending, especially on major purchases, like houses, which in turn affects GDP growth.

One recent proposal is the New College Compact, which features the tagline, “Costs won’t be a barrier. Debt won’t hold you back.”  Let’s take a look at this proposal, as we will be doing with a wide range of education proposals throughout the 2016 campaign season.

Briefly, here’s what the New College Compact proposes:

• Provide federal grants to states so that 4-year public state colleges could create “no loan” tuition plans and 2-year community colleges would be free.  States would have to agree not to reduce state spending on higher education, and to increase their spending over time;
• Set families’ payments for college expenses at “reasonable” rates;
• Cut the interest rate on federal student loans so that the federal government doesn’t “profit” on these rates (relative to the government’s cost of borrowing);
• Allow everyone with current student debt to refinance at today’s relatively low interest rates;
• Penalize colleges with low graduation rates where students leave with high student loan balances;
• Change college accreditation to make it easier for new providers and innovative modes of delivery to become accredited;
• Simplify the federal student loan application (i.e., the “FAFSA”);
• Require colleges to increase “transparency” about graduation rates, likely earnings and debt, and how these compare to other schools;
• Attempt to weed out “bad actors” among for-profit postsecondary institutions; and
• Allow more experimentation with online education (by allowing students taking such courses to draw federal financial aid for them).

Overall, the proposers of the New College Compact estimate that it will cost the federal government $350 billion over 10 years.  (And keep in mind that this is just the estimated direct cost of the program.  There are also the program’s indirect costs based on how it is financed – whether through increasing tax revenues as the Compact proposes, cutting other federal spending, or increasing the deficit – that need to be figured in the proposal’s overall cost.)

The Compact has lots of moving parts to analyze.  In today’s post I’ll focus on that first bullet point – making state colleges loan- or tuition-free.  Subsequent posts will take up other aspects of the proposal.

Grants to States for “No Loan” 4-Year Colleges and Free Community Colleges

The idea here is that approximately half of the $350 billion in federal spending would go to states so that they could: 1) make community colleges tuition-free; and 2) lower tuition at state 4-year colleges to levels where students could afford them without student loans.

People consume more of pretty much anything when the price (to them) is reduced.  So reducing tuition in these ways would substantially increase the numbers of students enrolling in public institutions from two sources:
• “New” students enrolling in college who wouldn’t have done so otherwise because they felt the price was too high.
• Shifting of students who previously would have attended private colleges into public institutions, because the already-significant price break at public schools has become even bigger.

Increased enrollment in public institutions will mean higher overall spending on higher education, since total spending equals the number of people attending times the cost per student, even if the costs facing students and their families decline.  Under the Compact, this increased spending would be covered by the state and federal governments.

So is higher overall spending (aka “investment”) on postsecondary education a good or a bad thing?  After all, higher education can help reduce the “skills gap” – the mismatch between the skills employers are demanding and those supplied by job applicants – and increase Americans’ education, skills, and future earnings.  The Compact would have households spending less on higher education, and federal and state governments spending more.  Government spending is not necessarily bad per se, and in fact has net benefits when spent on the right things.

Education is one of those goods in which the benefits – such as higher earnings, improved health, better life outcomes – accrue mainly to the individual who obtains the education.  But the benefits also spill over to the larger society, in the sense that places with more highly skilled and educated populations tend to generate more innovations, experience higher economic growth, and tend to generally be more stable.  That is, education generates positive externalities, and positive externalities are one of the classic justifications for government spending, if the value of those benefits to the general public (and not just to the individual obtaining the education) exceed the cost of the spending

Investing more in postsecondary education, especially at public expense, is a good thing if it leads to more students completing degrees and certifications that lead to higher earnings.  But not all degrees are created equal.  Some increase earnings much more than others.  Others do not increase earnings enough to justify the investment of time and dollars involved.  Enrolling in college without completing a degree or certification has minimal impact on increasing earnings.  To the extent that the Compact encourages young people to enroll in college (because it’s free or low-cost), and they pursue coursework that does not increase their earnings or they fail to complete their course of study, this will be money wasted.  By shifting the spending from families to state and federal governments, it will be money wasted at public expense.

Rather than lowering tuition for all students, a better alternative would be to target public subsidies to disadvantaged students who are enrolled in courses of study that employers are demanding and that are likely to increase the student’s earnings.

Why Has Tuition Been Rising So Fast at Public Colleges?

The Compact would prohibit states from cutting their spending on higher education.  And it’s true that part of the reason that tuition is rising at public state colleges is because states have been reducing their subsidies to state schools.  In 2003 public state colleges received almost a third of their revenues from states and 17% from tuition.  By 2012 state payments had declined to less than a quarter of revenues at public colleges, while tuition had grown to 25%.  

States are reducing their spending on higher education due to the rising cost of mandated programs like Medicaid, combined with the requirement that states balance their budgets (i.e., no deficit spending).  This is just one example of how our failure to deal with healthcare spending is crowding out discretionary state spending on programs like higher education.  We can push higher education over into the “mandated” spending list for states, by freezing spending at current levels or higher, but that will force states to either cut spending on the remaining discretionary programs – like K12 education – or to raise taxes.

Unintended Consequences

Public policy is replete with examples of unintended consequences.  To the extent that the Compact increases enrollment at public institutions substantially, it may have the perverse effect of making these campuses more crowded and potentially reducing per-student spending, which will impact quality.  The Compact would prohibit states from reducing their spending on higher education, though it is not made clear whether this is total state spending or state spending per student.  If it is total state spending, then one can imagine a situation where the increase in the number of students attending public state colleges is so great that even the combination of current levels of state spending plus new federal grants is not enough to maintain current levels of per-student spending. This happened, for example, in the Cal State system, where too many students tried to get into too few course sections, leading to long wait lists for required courses and increased time to graduation.

Another possible unintended consequence of the Compact is that more small private colleges may close as the price differential between public and private colleges becomes even bigger and enrollments shift from private to public schools.  Many small private colleges with small endowments are already experiencing financial hardship.  Expect more of them to go under if something like the Compact is enacted (think Sweet Briar College).  The Compact proposes some federal subsidies for private schools, but only if they have small endowments and serve large numbers of low-income and minority students.  That targeting is probably appropriate for public spending.  Whether the closing of small private colleges is a problem or not depends on your point of view.  But the public should understand that a plan like the Compact will likely lead to the closure of more such schools.

Is the Compact Likely to Be Enacted as Envisioned?

If the federal government were to enact the Compact, many states, especially those with Republican governors or legislatures, might decline the offer.  Think states’ failure to adopt Medicaid expansion under the Affordable Care Act.  Apparently public colleges will be allowed to partner directly with the federal government in cases where their state government declines, but that will certainly make for some interesting politics.  (Consider Wisconsin, for example, where the governor and the state university system are already at odds...)  And if state colleges partnered directly with the federal government, what would the colleges need to promise in return: not to raise tuition?  Even in the face of potential future reductions in funding from other sources, such as the state legislature? (Presumably, if the state government in question had already declined the Compact’s offer of a federal grant, then that state would not be bound to maintain funding for higher ed at existing levels.)

Would the Costs of the Compact Really Be $35 Billion Annually in the Out Years?

Those proposing the Compact estimate its 10-year direct costs to be $350 billion, but no detail is given, so this figure should probably be taken as an order-of-magnitude, ballpark figure.  The $350 billion figure over 10 years probably averages in low take-up in the early years, with higher take-up (and cost) in later years.  One estimate I’ve seen suggests that the cost might be more like $70 billion annually by Year 10, which implies higher annual costs from that point forward.  In any case, the direct costs are quite substantial, which make the question of how the program would be paid for all the more salient.

[Coming in Part 2: assessment of the other components of the New College Compact]