Rising income inequality in the United States is playing an important role in the higher prices for college education, according to a recent research paper published in American Economic Review.
Economists have studied and speculated about the rising cost of colleges in the United States for some time, blaming ever-increasing prices on declining government funding, inflating operating costs, and exorbitant tuition discount practices. While a combination of factors contribute to each institution’s pricing, a new study by Zhifeng Cai, associate professor of economics at Rutgers University, and Jonathan Heathcote, a monetary advisor in the Research Division of the Federal Reserve Bank of Minneapolis, points to a widening income gap as a major driver of higher net education prices.
Together, the effects of higher income inequality and higher average incomes accounted for more than half of the increase in average net tuition fees in public and private four-year institutions between 1990 and 2016, according to the Kay and Heathcote model.
The authors also write that increased income inequality could explain the growing gap between the average poster price and the average net tuition fee. The sticker price, or list price, is the total published tuition price for each institution, and the net price is the amount students and families pay out of their pocket after taking into account federal and institutional financial assistance.
The authors are of the view that the educational quality of an institution is closely related to the average ability of its students. As a result, all colleges and universities are motivated to accept “high-potential” students, regardless of their income, in order to improve the quality of the education they provide. As income inequality grows, institutions must offer larger discounts to high-ability and low-income students.
This pricing strategy, called tuition fee discounting, is widely used by private institutions. It allows institutions to set high poster prices for their wealthier students and subsidize these prices for low-income students. Most private colleges discount tuition to some extent, and very few students actually pay the stated price.
Bill Hall, president and founder of Applied Policy Research Inc., a higher education consultancy, has helped colleges and universities develop education and financial aid strategies for some time. The advice he was giving many clients was the same: “High tuition, high aid.”
“I am no longer the high-tuition guy. We have been aware of the broad price sensitivity of low-, middle- and high-income families. Prices for higher education have gone up faster than almost anything in American society,” Hall said.
High tuition prices and big discounts for talented low-income students have helped some colleges diversify their student bodies, said Ronald Ehrenberg, an economist and professor of industrial and labor relations at Cornell University.
“Many of these institutions made the decision to try to attract more students with relatively low incomes, and they had to increase the generosity of their financial aid policies for these students,” Ehrenberg said. “But unless you can create new sources of income, it means you have less revenue to do anything else.”
Wealthy institutions – including Harvard, Yale and Princeton universities – can rely on their ballooning endowments to fund financial aid. Ehrenberg said institutions with less financial flexibility — which include most colleges and universities — need more income from tuition fees or public funding to fund more enrollment of low-income students. As a result, these institutions choose to set higher prices for their richer students in order to subsidize tuition fees for poorer students.
Higher income inequality also increases the wealth of higher-income students, the study authors wrote, motivating colleges to charge more money to these students. Doing so allows institutions to offset larger scholarships paid to high-potential and low-income students.
“The student body will tend to be a mix of relatively affluent, lower-ability students who pay relatively high fees and relatively poor but higher ability students who have a discount on tuition fees,” the paper says.
David Feldman, Professor of Economics at the College of William and Mary, praised the authors for creating a model that captures many of the key factors of the higher education market, but is not convinced that rising income inequality is directly causing an increase in average net income. Education prices.
“They are absolutely right that the income distribution over the past 40 years has become more skewed or unequal. At the same time, average net tuition fees have gone up,” Feldman said. “What I’m not clear about is causation.”
Feldman has another theory as to why university prices are so high – cost sickness. While many industries have experienced increases in productivity in recent years, these increases have been concentrated in industries that produce things, such as manufacturing, mining, and agriculture. Feldman said that service industries, such as daycare, medicine, legal services and higher education, have not experienced such a boom in productivity. This is because it is difficult to increase productivity in these industries without compromising quality.
Feldman said that cost sickness is “a natural consequence of industries that have experienced low productivity growth.” Because even though colleges and universities cannot increase productivity by teaching more students without sacrificing educational quality, their operating expenses continue to rise.
Kay and Heathcote note that although income inequality can reduce the number of students pursuing college, higher average incomes nullify this effect.
By themselves, increased income inequality would lower enrollment rates, but we find that growth in median incomes and more generous subsidies to colleges are opposite forces that have pushed more people to attend college,” they wrote.