Part 2 | Financial Aid Is Godsend for Some but Boosts Price for Others

May 5, 2008

Second of five columns
For release May 7 and thereafter
765 words

By Andrea Neal  

In 2004, economist Richard Vedder created a mini-sensation with his book Going Broke by Degree: Why College Costs Too Much. In a nutshell, the book argued that financial aid causes tuition to rise. “The evidence is pretty persuasive that massive governmental infusions of funds . . . have contributed to the upsurge in higher education costs,” he said.

The term financial aid most commonly refers to scholarships: direct grants that students need not pay back. The money comes from federal, state and university budgets and from private sources, such as endowments.Since Vedder’s book came out, the “upsurge” has continued. And though Vedder’s message has stayed controversial, policymakers are starting to admit that the system designed to make college more affordable is making it less so.    

Here’s why. “When someone else is paying the bills, people want to buy more of the good or service in question at prevailing prices than when the customer pays the bills,” Vedder explains. “This means a higher demand for higher education, and other things being equal, higher tuition costs.”
How much higher? According to Vedder’s estimate, “each one dollar in grant aid leads to tuition fees somewhere around 35 cents higher than would otherwise be the case.”
The effects are significant. Indiana public university students received $635 million in grants from federal, state, private and university sources in 2005-06 (the latest year for which totals are available). That works out to $4,500 per recipient. If Vedder’s formula is correct, the resultant tuition increase for public university students was $222 million.
An often-used analogy is the third-party payer health care system. Its price hikes, like higher ed’s, have outpaced inflation for decades. As long as someone else pays, in this case the insurer, there’s no incentive for providers to keep expenses down and no reason for patients to demand it. It’s no coincidence that one of the few medical procedures whose price has been dropping is laser eye surgery, which is rarely covered by insurance.
The problem isn’t just that financial aid distorts the market; it doesn’t work as intended.
In 2006, the U.S. Commission on the Future of Higher Education reached two troubling conclusions: 1. College costs more because of  “a financing system that provides limited incentives for colleges and universities to take aggressive steps to improve efficiency and productivity.” 2. The aid system is “confusing, complex, inefficient, duplicative and frequently does not direct aid to students who truly need it.”
That’s certainly the case in Indiana where a growing percentage of financial aid is used to attract the most talented students to campus. That’s a worthy goal, but it works at cross-purposes to attracting the neediest. According to the Indiana Commission for Higher Education, almost 70 percent of aid given out by the four-year residential colleges in 2005-06 went for merit and not need.
Grants for need are based on a 12-part formula and determined by family financial data collected on the federal Free Application for Federal Student Aid (FAFSA), which Vedder has described as more confusing and harder to complete than the IRS 1040 tax form.
At the moment, no politicians are taking Vedder up on the suggestion to consider ditching taxpayer-funded aid. What is under discussion are proposals to make the system more accountable: to make sure aid is going to the poorest students and to require universities to implement cost cutting strategies that consumers would demand if they were paying sticker price.
Indiana’s Commission for Higher Education has established working groups that have made specific recommendations on affordability and access, which will be voted on in June.
Ideas on the table include: Indiana could stop following the federal formula for determining state grant awards and use a simpler process. It could, for example, limit eligibility factors to two items: family income and family size. Dependent students with family incomes of $25,000 or less would qualify for a full tuition grant. Those with family incomes between 25,000 and 40,000 would qualify for a partial grant. Another option would be to provide the first two years of college free to students from families with incomes less than a given amount, say $44,000.  
“For higher education for the last 50-plus years the theme has been access,” says Indiana higher education commissioner Stanley Jones. “Access is important. We’re trying to change the conversation in Indiana to accountability.”
Financial aid is probably here to stay. Gov. Mitch Daniels, for one, has proposed a massive new program to help pay tuition for families making less than $54,000 a year. The challenge is to eliminate the inflationary effects caused by the third-party payer system.

Andrea Neal, an adjunct scholar with the Indiana Policy Review Foundation and former editorial page editor of the Indianapolis Star, teaches history at St. Richards School in Indianapolis. Contact her at


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