The Economics Of College Costs

Background for President Obamas College Tour August 22nd 23rd

Hamilton Place Strategies provides communications, policy, and advocacy solutions at the intersection of business, government, and media.

Executive Summary
President Obamas college tour will address the growing concern over high student debt levels and college affordability. This document provides a backgrounder on the economics of this important topic. The highlights are: Investment in a college education is still worth it, despite increasing levels of debt. The college wage premium, while stagnating recently, is still high with median income of college graduates 93 percent above those with a high school degree. Higher debt levels have reduced the return but college is still a prerequisite for higher income. However, there is a fundamental link between policies increasing access to higher education and higher student debt levels. By subsidizing the cost of college, the government is increasing demand for college. Given short-run supply constraints, more demand increases prices, reducing the return on investment in higher education. Current proposals look to increase price sensitivity for either students or schools. Cuts to student subsidies make them more cost conscious on college and major choices. Restrictions to access for federal loans or Oregons new approach encourages colleges to provide a more valuable education or restrict riskier students. Ultimately, efforts to ease the student debt burden are no free lunch. For students where college is a borderline investment, they may choose to opt out of four-year programs due to cost or be denied access by schools due to risk.
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VALUE OF COLLEGE

While Stagnating Recently, The College Income Premium Has Increased Significantly Since 1975
Median income of workers over 25 by educational attainment 2010 dollars

200
Index (High School Graduate = 100)

+93%

175 150 125 100 75 50 25 0 1975

Less than 9th grade High school dropout High school degree Some college College grad As the US has shifted to a knowledge-based economy, the value of a college degree relative to a high school degree has risen substantially. Since 1973, the college income premium has risen from 40% to 93%, while those without high school degrees have seen their incomes drop from 72% to 65% of high school graduate income.
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1980

1985

1990

1995

2000

2005

2010

Source: 2010 CPS

VALUE OF COLLEGE

Further, In Todays Economy, Employment Prospects Are Much Improved With A College Education
Unemployment Rate In July 2013 By Educational Status

11 10 9
Unemployment rate

11.0%

Like the unemployment rate, the participation rate also correlates with educational status.

8 7 6 5 4 3 2 1 0
Less Than High School

7.6% 6.0%

3.8%

Forty-five percent of high school dropouts participate in the labor force, compared to 59, 67, and 76 percent of people with high school degrees, some college and associate degrees, and bachelors degrees or higher respectively.

High School

Some College or Associate Degree

Bachelor Degree and Higher

3

Source: BLS

IMPACT OF COLLEGE DEBT

However, The Increases In Student Debt Have Reduced The Return On College Education
Median income of college graduates and average student debt at graduation 55 50 45 Average Student Debt at Graduation Median Income of College Graduate At the current pace, student debt at graduation will equal the median income of college graduates in 2023. Debt at graduation has increased by over 200% since 1993 while median income for college graduates has decreased by 1%. The faster increase in debt reduces the return on college education.

2012 Dollars (000s)

40 35 30 25 20 15 10 5 0

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

Source: FinAid, 2012 Current Population Survey

2012

IMPACT OF COLLEGE DEBT

And The Cost Increases Driving Debt Have Risen At Least Partially Due To Subsidies
Increases in costs and funding sources of college education 24 22 20 18 16 14 12 Average Total Aid per FTE Average Tuition and Fees 4-Year

By reducing the price sensitivity for college, government has fueled more demand for college attendance and increased services. In total, college tuition and fees have increased over 200% since 1977, far outpacing CPI. Even more dramatic increases in debt and aid is helping enable this cost growth. Increased access to debt is a growing component of education finance.

2012 Dollars (000s)

10
8 6 4 2 0 Average Federal Loan per FTE

Source: National Center for Education Statistics, College Board Trends in Student Aid

1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

IMPACT OF SUBSIDIES

Subsidies De-Sensitize Students To Prices In The Near Term, Leading To Higher Costs And More Debt
Impact Of Subsidies Short answer: Subsidies improve access, but, by increasing demand, also raise costs. Long answer: As depicted in the causal loop diagram to the right, as the economy shifted to become more knowledge-based, the return on investment in higher education increased, boosting demand. With constrained supply, demand increases prices. Higher prices increased debt levels, but also calls for subsidies and government support. However, subsidies only further increase demand leading to a vicious loop of higher debt and more subsidies. The result is a reduced return on investment for higher education. Causality of higher education financing Changing nature of U.S. economy

+ ROI in higher education

+ -

Positive causal link Negative causal link

+ +
Increased demand for education

+
Vicious cycle of higher debt and more subsidies Higher prices for education

Increased debt levels

Government subsidies

+ +
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POLICY PROPOSALS

Recent Policy Proposals Seek To Increase Price Sensitivity For Either Students Or Schools
Proposals that control costs by Incentivizing schools to provide better value Restricting access to federal loans to universities with quality outcomes is one way to protect student borrowers from low quality education. One proposal is to create a Qualified Student Loan.* "Pay It Forward" models** directly link payments to schools with the future income of graduates encouraging schools to improve earnings outcomes for students. Incentivizing students to seek a good deal The Know Before You Owe and college cost calculator attempts to provide more information to students about the quality of schools to steer them away from poor performers. Reduced loan subsidies through increasing interest rates or restricting borrowing would encourage students to be more cost conscious in their college choices.

Rather than controlling costs, income-based repayment (IBR) plans shift cost to the government and taxpayers.
*Joe Valenti and David Bergeron, How Qualified Student Loans Could Protect Borrowers And Taxpayers, Center for American Progress, 8/20/13) **Richard Perez-Pena, Oregon Looks At Way To Attend College Now and Repay State Later, The New York Times, 7/3/13)

POLICY PROPOSALS

The White House Plan Combines These Approaches

Component "Paying for performance" Details "Tie financial aid to college performance, starting with publishing new college ratings before the 2015 school year." "Challenge states to fund public colleges based on performance." "Hold students and colleges receiving student aid responsible for making progress toward a degree." "Promoting Innovation and Competition" "Challenge colleges to offer students a greater range of affordable, high-quality options than they do today." "Give consumers clear, transparent information on college performance to help them make the decisions that work best for them." "Encourage innovation by stripping away unnecessary regulations." "Ensuring that Student Debt Remains Affordable" "Help ensure borrowers can afford their federal student loan debt by allowing all borrowers to cap their payments at 10 percent of their monthly income." "Reach out to struggling borrowers to ensure that they are aware of the flexible options available to help them to repay their debt."
Source: The White House

Our take This is a notable proposal along the lines of a "Qualified Student Loan" and builds on the Administration's transparency efforts to date. It would likely lower cost pressures by reducing loan availability for marginal schools and marginal students who have had the most trouble with loan repayment and job placement. There are few specifics, and it's unclear how much impact the administration can have. The technological innovation that is happening in higher education is real and may help price pressures in the future. Encouraging and highlighting these trends can't hurt. This is not new, but it won't reduce upward cost pressures and may actually make them worse.

Effectively, income based repayment plans are just a different kind of subsidy where the government/taxpayer is on the hook instead of the student.
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