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How can it be? Student financial aid fuels increase in college tuition. (+Video)

When federal (and state) financial aid programs make money available to well-off students, it is in a college's interest to capture that aid and use it to 'improve' the college, thus driving up costs and tuition. Aid must be restructured so that more of it goes to needy students.

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Regardless of how money is allocated, the end result is that schools have an insatiable need for more money – a phenomenon described as (Howard R.) Bowen’s Rule, and thoroughly documented by Charles T. Clotfelter in “Buying the Best: Cost Escalation in Elite Higher Education.”

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Colleges know that students operate under the assumption that a college education serves as a passport to the middle class, and that students are willing to pay a significant amount to get one. So colleges act accordingly by charging them more.

Thus when financial aid programs make money available to well-off students, it is in the colleges’ interests to raise their tuition to capture that aid and use it to improve the college, or more accurately, its perceived quality.

Unfortunately, the increases in costs and tuition soon drive even those who are well off to beg for access to financial aid. And sure enough, by 2004 the median parental income of dependent unsubsidized Federal Stafford Loan borrowers was more than $75,000.

The end result is that the college has more money, which is often spent on dubious schemes to increase its perceived quality, such as paying faculty members to write the 21,674th academic piece on Shakespeare. Meanwhile the government and the students struggle to come up with ever increasing amounts to pay for college.

All of this is not to say that students and their families, even relatively affluent ones, are not struggling with paying for college. But providing financial aid will not help those in the upper-income range – it will just allow colleges to raise their price while saddling students with more debt.

To be clear, bad financial aid design is not the underlying cause of the explosion in college costs – the root cause being competition based on reputation leading to the academic arms race. But federal aid does exacerbate the problem by pouring fuel on the fire.

This can largely be avoided with more careful design of federal (and state) financial aid programs. The more programs look like Pell grants (means tested, modest in size, empowering students rather than colleges), the better.

So far, little indicates that this is a priority or even recognized within influential higher education or public policy circles, which are virtually unanimous in calling for more federal financial aid spending. More money funneled through existing federal aid programs is not the solution, but smarter aid spending might be.

Richard Vedder directs the Center for College Affordability and Productivity (CCAP), is an adjunct scholar at the American Enterprise Institute, and teaches at Ohio University. Andrew Gillen is the research director at CCAP and is an adjunct professor in Washington DC.

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