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College tuition is one of the fastest-climbing prices in the modern economy. One proposed culprit for rising tuition at public colleges and universities is the “state disinvestment hypothesis”—the idea that tuition has risen because states have cut back on the direct subsidies they provide to public colleges. Since 2004, per-student direct subsidies to four-year public colleges have fallen by 15 percent, while net tuition rose by 56 percent over the same period. It is tempting to infer a link between the two.
However, the state disinvestment hypothesis falls apart upon closer scrutiny of the data. This report uses a fixed-effects regression method, which isolates underlying tuition trends from fluctuations plausibly caused by state disinvestment. At four-year public colleges between 2004 and 2015, every dollar of per-student subsidy cuts was associated with a tuition hike of less than five cents. State subsidies appear to have little, if any, effect on tuition levels at public colleges.
Rather than increasing tuition, public colleges respond to subsidy cuts by reducing spending, specifically spending in areas not related to instruction such as research and administration. For every three to five dollars in subsidy cuts, spending on instruction goes down by one. Perhaps intuitively, expenditures tangential to the central educational mission of universities are the first to go when subsidies fall.
These findings have multiple implications. First, colleges appear to maximize tuition revenue at all times, and other revenue streams such as state subsidies are mostly independent from trends in tuition. Therefore, even if states had kept higher education subsidies at prerecession levels, the upward trend in tuition would be little changed.
Second, were state governments to restore higher education subsidies lost during the Great Recession, universities would largely not use those funds to defray tuition for students or increase spending on instruction. It would take a $20 or more increase in per-student direct subsidies to achieve just a one-dollar reduction in tuition. State policymakers aiming to reduce tuition burdens should look to policy tools besides direct subsidies.
Why has college tuition risen faster than the overall rate of inflation over the past half-century? Scholars have offered various theories, including slow productivity growth and the wide availability of government subsidies. For public colleges, one possible explanation is the “state disinvestment” hypothesis. In recent years, state and local governments have reduced, on a per-student basis, the direct subsidies they provide to public colleges and universities in their jurisdictions. The state disinvestment hypothesis holds that to compensate for the lost subsidy revenue, colleges have increased tuition.
During the 2016 presidential election, Democratic nominee Hillary Clinton cited the state disinvestment hypothesis as a justification for her higher education policy proposals. “The barriers to obtaining a degree are becoming increasingly steep,” Clinton’s platform read. “The recession accelerated the trend of state disinvestment in higher education. . . . Colleges have responded not by tightening belts but by raising tuition, passing the costs on to students and families.” Clinton went on to propose a large federal investment in state public higher education systems with the aim of lowering or eliminating tuition.1
Proponents of the state disinvestment hypothesis are correct that reductions in direct subsidies to public colleges have coincided with increases in tuition. In 2004, public four-year colleges received $8,856 in direct subsidies from state and local governments for every full-time equivalent (FTE) student they enrolled.2 However, that figure fell to $7,537 by 2015—a reduction of $1,319 or 15 percent. Meanwhile, tuition revenue per FTE student at these schools rose from $6,223 to $9,711 over the same time period—an increase of $3,488 or 56 percent.3 (All figures are adjusted for inflation.)
Figure 1 illustrates these trends. From 2004 to 2008, tuition and direct subsidies both rose at a steady rate. During and immediately after the Great Recession, tuition continued to rise. However, many states simultaneously made cuts to the portion of their budgets allocated to higher education to deal with falling tax revenue. Combined with a large increase in student enrollment, these cuts caused direct subsidies per student to fall substantially. The decline continued until 2012, when rising aggregate subsidies and flat enrollment caused direct subsidies per student to level off.
Proponents of the state disinvestment hypothesis often present the twin trends of rising tuition and falling subsidies as evidence of a causal link between the two.4 But this argument has two shortcomings. First, it fails to explain why tuition rises even during periods of increasing direct subsidies, such as 2004 to 2008 and 2012 to 2015. This phenomenon points to an underlying trend in tuition revenues that is independent of changes in direct subsidies.
Second, the divergent trends in tuition and direct subsidies are presented only at the aggregate level. Factors other than subsidies might have driven the rise in tuition during the recession, but we would never know it just by looking at the overall trends. Examining whether trends in tuition and subsidies line up at the institution level is necessary to identify the strength of the relationship between the two.
This report provides institution-level evidence on the relationship between tuition revenues and direct subsidies at public institutions. Specifically, it seeks to identify what share of reductions in direct subsidies are “passed through” to higher tuition revenues and vice versa. For instance, if a $100 reduction in direct subsidies per student causes a $50 increase in tuition, the pass-through rate of subsidies to tuition is 50 percent. If such a reduction causes a $100 increase in tuition, then the pass-through rate is 100 percent. If changes in direct subsidies cause no changes in tuition whatsoever, then the pass-through rate is 0 percent.
The state disinvestment hypothesis has formed the justification for numerous proposed and enacted public policies on the state and federal levels. Proponents argue that reversing Great Recession–era “disinvestment” in public higher education will lower tuition or at least slow the rate of increase.5
Implicit in this argument is the assumption that the pass-through rate of subsidies to tuition is high. But this assumption is inappropriate without verification. If the true rate of pass-through is low, then even large increases in direct subsidies will have little effect on tuition. Large taxpayer investments in higher education with the aim of lowering prices for students could thus waste billions of dollars.
Policymakers need reliable estimates of pass-through before increasing direct subsidies for public colleges with the aim of lowering tuition. This report will review the existing evidence on the relationship between direct subsidies and tuition and provide new estimates of the pass-through rate.
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