The Aid Game
The enigmatic economics of college financial assistance
by Thomas J. Kane
For decades, parents have worried about where their children will be admitted to college and how much college will cost. Moreover, during the past 15 years, the rising economic value of obtaining a degree has raised the stakes for the families who spend their fall weekends filling out college applications. It may be small comfort for these parents to realize that the sword hangs ominously over college admissions officers as well, as they strategize about admitting a class that will both please their faculty members and impress the college-guidebook writers.
Two recent books will help parents understand how the world looks from the perspective of college financial-aid offi-cers. In Crafting a Class, Elizabeth A. Duffy and Idana Goldberg trace the history of admission and financial-aid policies among a set of liberal-arts colleges in Massachusetts (excluding Harvard) and Ohio, using historical documents and admissions data to identify colleges' responses to the G.I. Bill of the 1950s, to the "tidal wave" of college applications during the 1960s, to the enrollment of women in the 1970s, and, finally, to the increasingly competitive pressures of the past two decades. The book is filled with excerpts from internal documents, written by college presidents and financial-aid administrators, arguing over the tactical use of aid and admissions policy.
While Duffy and Goldberg focus on the history of financial aid, Michael S. McPherson and Morton O. Schapiro write about it in The Student Aid Game from the perspective of two economists who have long studied broader policies affecting financial aid. Because they are primarily interested in how federal policy might more effectively open the doors to college for low-income youth, McPherson and Schapiro, like good economists, analyze the effects of financial-aid programs on the incentives of colleges and parents, and anticipate the impact of recent changes in the tax code on colleges' tuition and aid policies.
Crafting a Class: College Admissions and Financial Aid, 1955-1994, by Elizabeth A. Duffy and Idana Goldberg (Princeton University Press, $29.95).
The Student Aid Game: Meeting Need and Rewarding Talent in American Higher Education, by Michael S. McPherson and Morton O. Schapiro (Princeton University Press, $29.95).
Compared to most other economic actors, colleges are enigmatic institutions. On the one hand, financial-aid officers occasionally set prices in a way that would make a car salesman blush. In 1996, for instance, the Wall Street Journal reported that at least one institution offered less aid to applicants who traveled long distances to visit its campus, using such behavior as an indicator of a student's attachment to the school. On the other hand, these same institutions regularly turn away thousands of applicants willing to pay the full sticker price, while offering generous financial-aid packages to low-income students.
As described in these books, colleges differ from the typical economic producer in two fundamental ways. First, students are not only customers, but also inputs in the educational process. For whatever reason--the boost given by an alma mater's reputation when a graduate enters the labor market, or because of the pedagogical magic that happens when one assembles a group of talented students, or because good students attract talented faculty--the prior academic preparation of a student's classmates plays an important part in creating the value of any college's "product." Regardless of their greater willingness to pay, wealthy students with poor academic preparation may actually "cost" the institution more than low-income students with stronger academic credentials, because of the contributions that talented students can make to the education of their classmates.
Second, colleges, unlike most local car dealers, also function as charitable foundations, using the resources bequeathed by earlier generations--in the form of endowment income or of scenic campuses--to pursue other social goals, such as greater racial understanding or socioec-onomic mobility or the reciprocal education of students by their peers.
Both books recount the endless battles fought over the appropriate mix between "need-based" and "merit" financial aid--the latter term describing awards given on any basis other than financial need, such as athletic ability, superior test scores, or an interest in Renaissance literature. To parents whose children are academically qualified for admission, but whose family circumstances disqualify them for aid on the basis of need, this can become an emotionally charged dividing line.
For many financial-aid professionals who believe that every dollar spent on merit aid reduces funding for the need-based variety by a like amount, the annual allocation between merit and need-based aid is a holy war. Yet both sets of authors suggest that the trade-off between a dollar in merit aid and a dollar in need-based aid is probably not one-for-one. Because a college's customers also help manufacture the educational "product," merit scholarships for academically talented students may often substitute for a new coat of paint on dormitory windows or salaries for assistant professors as a means of improving that product. Thus, even though merit and need-based aid may be administered by the same office and drawn from the same budget in any given year, financial aid is just one of many lines in the overall budget of a university. In the long run, one dollar more for merit aid may mean one dollar less for faculty fringe benefits or for magazine subscriptions for the library, rather than any reduction in the need-based aid budget. Indeed, limiting financial aid to need-based grants and loans may tie a school's hands, leading to a wasteful expenditure of its resources on less efficient means for improving students' learning--such as increasing senior faculty salaries.
Determining the appropriate trade-offs grows ever more challenging. As applicants shed their regional loyalties and the market for college becomes a more national one, all but a handful of colleges have become "price-takers" rather than "price-setters." A school whose students have a mean SAT score of 1100, for example, is increasingly likely to find that there is a uniform maximum price that a student with an SAT of 1400 would be willing to pay, regardless of need, to attend. For a local football franchise or an airline, differing prices for different buyers of the same product are often a sign of the producer's market power. But in higher education, since the consumers contribute in varying degrees to their classmates' learning, such price discrimination reflects the colleges' declining market power: they may have no choice but to bid for the limited number of star students, like owners of baseball franchises offering riches to the few certifiably dominant pitchers available as free agents.
The rising payoff from elite education and the proliferation of college rankings (which rely heavily on readily measured indicators such as a college's mean SAT score) mean that the differences in the contributions made by students with strong and weak academic credentials have widened. In the old days, a college's reputation was built upon an amorphous mix of perceived selectivity, quality of the faculty, and the square footage of the library. Now, given the visibility of national rankings, the marginal impact on its reputation of a change in a school's mean SAT score from year to year has almost certainly increased. As a result, colleges are concerned not only about admitting a solid pool of students, but being able to appear to have done so using easily measurable criteria. In such an environment, applicants' compelling essays--read by admissions officers, but not by the public--matter less, and test scores and high-school rank matter more. From the colleges' perspective, it is a whole new world.
Duffy and Goldberg describe how the rise in applications during the late 1960s and early 1970s led many selective colleges to expand enrollment, for instance, by opening the doors to women. It is interesting to note that these same colleges did not similarly expand when they were flooded with applications during the 1980s and 1990s. During the 1970s, as the payoff from attending college was falling, it was much less costly to expand and admit additional students, since colleges were less likely to be punished for any decline in selectivity. But ever since the late 1980s, with U.S. News and World Report looking over colleges' shoulders, any expansion that led to a decline in the average academic qualifications of the student body would have proved quite costly. Rather than expanding, selective colleges became more selective as demand for their services boomed.
Are colleges justified in extracting more tuition revenue from students who signal greater attachment to the institution--the practices outlined in the Wall Street Journal article? One might think of a particularly scenic campus or the emotional attachments of alumni children as being part of an institution's endowment, bequeathed by earlier generations. Practices that might seem unfair to applicants--keeping track of a student's emotional attachment and using that information in making financial-aid offers--appear from the institution's perspective as analogous to investing the university's endowment wisely. Indeed, an argument could be made that institutions bear a fiduciary responsibility to get the highest return from all their various assets--not just the portion invested in financial instruments.
There may be some good news for advocates of need-based aid in the increasingly competitive market. The same market forces that compel university leaders to consider merit aid also provide them with additional leverage in their pursuit of larger social goals. An additional dollar spent on need-based financial aid at one institution may force peer institutions to take comparable action. As evidenced by the reaction to their initial announcement of financial-aid changes last year, the trustees at Princeton obviously succeeded in targeting a larger set of resources than the additional $2 million that they expect to spend per year. Indeed, if one were to combine the annual costs of the Harvard, Stanford, and Yale initiatives announced in response to the Princeton reforms, the cumulative increase in aid for middle-income students created by the Princeton decision was $17 million--more than 8 times larger (a total since further expanded by enriched aid budgets recently announced by Cornell and Dartmouth). In other words, the proliferation of competition has also increased the "multiplier" effects of any one college's financial-aid decisions. It is this kind of systemic thinking about aid that readers of these books will find themselves better equipped to perform.
That said, the books do not address two other important issues in financial-aid policy. First, the already high tax rates on family income and savings in need-analysis formulas suggest that institutions should consider alternative forms of means-tested aid. The bill for tuition, room, and board at elite institutions now exceeds $30,000 per year. Any plan seeking to ensure that low-income youths receive close to full scholarships, while charging high-income students close to the sticker price, necessarily implies very high tax rates on parental resources. For instance, suppose that those with parental incomes of $40,000 or less pay nothing, while those with incomes of $100,000 or more pay the full cost. Taking away a $30,000 benefit over an income range of $60,000 ($100,000 minus $40,000) implies a marginal tax rate of at least 50 percent--rather high rates indeed, when added to existing taxes. No wonder parents find the aid process discomfiting. Income-contingent loans, based on the income of the youth rather than the income of the parents, may provide an alternative way to target additional means-tested aid.
Second, it is well known that earnings differences between high-school and college graduates have widened dramatically since 1980. Even in 1980, there were very large differences in rates of college-going based on students' family income. These differences can be attributed only partially to differences in high-school grades and test scores. Had there been no change in the tendency to go to college based on family income, these two facts would imply that--all else equal--parents' income would have a larger impact on their children's expected income than before. Now, however, some evidence suggests that the gaps in college entry by family income seem to have widened. Although changes in financial-aid policies at elite private institutions are unlikely to affect the youths currently choosing work over schooling, these facts highlight the importance of McPherson and Schapiro's analysis of the role of federal financial-aid programs. For whether we realize it or not, beyond the impact on individual students and families, the increasing economic effect of attending college, and the diverging tendency to do so (based on family income), means that during the past two decades, social mobility has been put at risk as never before.