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Is College Unaffordable?

Tuition and student debt have skyrocketed, but higher education still pays off.

December 1, 2005


Ron Wirtz Editor, fedgazette
Is College Unaffordable?

Just what is a high school grad to do these days?

Higher Education ImageOn the one hand, everyone and their guidance counselor will tell you that college is mandatory after graduating high school. It doesn't take an economics degree to see the pay stub difference between a college degree and a high school sheepskin.

But have you seen the cost of college these days? Tuition hikes have been averaging upwards of 10 percent for several years running, and that's only the half of it. Some online tuition calculators suggest that total costs for a private college might pass $100,000 a year by the time today's infants hit their ivory tower desks.

So a student's stuck in a Catch-22: Can't afford not to go to college, but can't afford to go to college.

The utility of a college education is widely embraced, and with good reason. Both private and public returns to higher education are considerable. When it comes to personal income, for example, the average college graduate can expect to earn about 73 percent more over a career than someone with a high school diploma (though that fluctuates depending on the degree), according to the College Board. Quite outside esoteric arguments for higher education—like the need for an educated electorate—a student's decision to attend college often starts and stops at this simple income argument: Go to college, get a better job and earn more money. If there's some extra stuff like culture and increased civic-mindedness—bonus, dude.

But an argument gaining traction is that students—particularly those of modest means—can no longer afford college. Much of the debate agonizes over rising tuition—the supposed offspring of cash-strapped universities, penny-pinching state legislatures and stagnant Pell grants—and secondary effects of increased student loans and rapidly rising student debt.

It makes for a good story. But these purported problems are not having quite the effect feared by many. Enrollments have been climbing (not receding), higher education revenue has exploded (not imploded) and student debt remains manageable for most. And the clincher: Research shows that even given its higher cost, college is still well worth the investment.

Price of admission going up

To be sure, it's not hard to hit the affordability alarm button after even a cursory glance at tuition trends.

For the 2005-06 school year, tuition at public colleges rose by an average of 8 percent, according to the American Association of Colleges and Universities. Might seem high, but that's actually a significant decrease over recent years. Last year, average tuition rose more than 10 percent; the year before it was 14 percent.

In fact, big tuition hikes are more the rule than the exception. In constant 2004 dollars, average tuition over the previous decade (from the 2004-05 academic year) has risen 51 percent at public four-year schools, 36 percent at private four-year schools and 26 percent at public two-year schools. And those were the good years. Adjusted for inflation, tuition has roughly tripled since the 1970s.

Policymakers and students tend to attribute higher tuition to declining state appropriations. On the surface that connection makes sense, but the reality is more complicated. State appropriations as a percentage of higher ed revenues have been going down, from 50 percent in 1980 to about 30 percent today. Yet despite this Scrooge-like appearance, state appropriations actually rose from 1990 to 2004 by 44 percent (inflation-adjusted) to $62 billion.

The bright orange elephant being ignored in the classroom is accelerated spending by colleges and universities. Annual expenditures by the nation's public degree-granting colleges and universities doubled from 1990 to 2001 to $177 billion (in constant dollars, spending grew 44 percent). Enrollment growth is responsible for only some of the higher spending. In constant dollars, annual expenditures per full-time equivalent student rose from $22,000 in 1990 to $29,000 in 2001 at four-year public universities, according to the National Center for Education Statistics (NCES), a data-gathering arm of the U.S. Department of Education.

Where does the money go? Lots of places. Though overall faculty salaries have been held somewhat in check (a 6 percent increase after inflation from 1990 to 2001), the number of faculty has risen about twice as fast as enrollment over this period, and the number of nonprofessional staff has been rising faster still. Though comprehensive figures are tough to come by, universities also have been on a building binge, erecting new and expensive laboratories, classrooms, dormitories, student unions and other edifices to help them compete for the best students and faculty.

You might have the impression that this is all being done on the backs of students through higher tuition. That certainly plays a part, but a pretty small one. From 1990 to 2000, total tuition revenue at public degree-granting institutions jumped from $15 billion to $31 billion, according to the NCES. The rest of the revenue pie is coming from lower-profile sources—like federal and state grants and contracts, gifts for operational and capital spending, endowment returns and revenue from teaching hospitals and auxiliary enterprises—all of which have also been on the steady rise. Today these "other" sources generate the majority of revenue for public colleges and universities; together, tuition and state appropriations make up only about 40 percent.

Those poor students

Still, as tuition rises, there has been a proportional outcry over the slow growth of grant aid, and specifically over the supposed modesty of federal Pell grants, which go predominantly to low-income and other financially needy students. Although annual Pell spending has doubled since just 1997 to more than $12 billion, average grants have not grown as quickly because more students are receiving them.

And in light of high tuition hikes, a Pell's purchasing power has been on the general decline. In 1980, a Pell grant covered about 35 percent of total costs (tuition, fees, and room and board) and somewhere around 80 percent of annual tuition to a public four-year institution, according to the NCES and College Board. By 2002-03, it covered only about 20 percent of annual costs and about 40 percent of annual tuition.

Yet the Pell obsession overlooks sizable and growing spigots of grant aid available from a multitude of sources. For example:

  • Grant aid from states doubled between 1994-95 and 2003-04, to $6.2 billion annually.

  • Non-Pell federal grant programs for veterans and other military personnel and students with special financial needs have risen about 85 percent over the last decade and now total $4.5 billion.

  • Private scholarship aid was likely about $3 billion in 2003-04, according to the Institute for Higher Education Policy. It put an "upper bound" estimate at more than $10 billion.

  • Though very little research exists on the topic, a growing portion of students are believed to be receiving financial assistance from their employers. In 1995, almost 6 percent of undergraduates received financial help from their employers (averaging $932), and almost 13 percent of graduate students received an average of $2,450 from their employers, according to an NCES investigation. Extrapolating that trend outward given rising enrollment, higher tuition costs and greater employer involvement in employee education, such aid today likely reaches—at least—into single-digit billions.

A growing number of indirect and nontraditional aid sources also subsidize college goers or otherwise help buy down the cost of paying for college.

  • The federal government offers tax credits for interest paid on student loans, not unlike the write-off homeowners get on their mortgage interest. In 2002, 6.7 million taxpayers claimed $4.5 billion in student loan deductions, according to the College Board. The federal government also has added tax advantages to college savings plans, like increasingly popular 529 programs that allow investments to grow tax free if used to pay
    college-related costs. The College Board reports that there are currently some 7 million 529 accounts with $54 billion in assets.

  • There is now a slew of what might be called back-end scholarship programs, most of them run by states, that forgive loans or provide tuition reimbursement to students enrolling in high-demand fields. The American Institute for Research identifies 161 "workforce contingent financial aid" programs in 43 states. One hundred of these programs reported a total of 26,000 individuals receiving such aid in 2001-02.

All of these aid channels are dwarfed by one of the single biggest grant aids—and best kept secrets—in higher education. Though regents, policymakers and students alike agonize over tuition levels, a significant number of students don't pay that sticker price, thanks to a growing practice known as tuition discounting (also called institutional grant aid).

Economists call this price discrimination, and it's a common practice in the airline industry. In both airplanes and university classrooms, there is a sticker price for a given seat, but that price fluctuates greatly based on the buyer's willingness and ability to pay. Colleges have the added advantage of getting long fiscal dossiers on anyone filing for financial aid. According to the College Board, higher education institutions doled out about $23 billion in tuition discounts in
2003-04—more than federal Pell and state grant aid programs combined, and half of all grant aid distributed.

The majority of that aid, however, is distributed by elite private four-year universities looking to buy down the cost of tuition in order to fashion an incoming class with characteristics (in terms of academic achievement, diversity and other matters) sought by the institution. Almost two-thirds of full-time students at four-year private schools received institutional aid in 1999-2000, compared to 49 percent a decade earlier, according to a 2004 NCES report. At four-year public institutions, the rate rose from 15 percent to 24 percent.

Add up all these pots of grant aid, and the affordability picture starts to get a little brighter, even at expensive private schools, because more students (not fewer) are receiving more (not less) total grant aid. A 2004 NCES report on financial aid finds that the percentage of full-time students receiving any grant aid increased from 51 percent in 1989-90 to 60 percent a decade later. It also finds that, in constant dollars, average grant aid grew by more than 20 percent. Studies by the NCES looking at "net tuition"—tuition minus all grant aid and inflation—generally find it to be mostly flat during the 1990s at
lower-cost schools and for students from lower-income households and, indeed, much lower than often portrayed in the media for all institutions and income levels.

Easy money

Of course, tuition is only part of the cost of going to college. Other costs—books, room and board, and various fees—have risen significantly as well, and more students are relying on more loans to make ends meet.

The number of undergraduate students taking out federal loans rose by 125 percent from 1993-94 to 2003-04, and the annual value of loans increased 152 percent to $56 billion, according to the College Board. This increase is due in part to a simple axiom: Students are borrowing more simply because they can. Over the last decade and a half, the federal government has made more low-cost money available to more students regardless of income. Apparently, even federal loans can't seem to satisfy demand, as private sector loans to students have exploded from virtually zero in 1993 to more than $10 billion in 2003.

Not surprisingly, students are piling up loan debt at a remarkable pace. A 2003 study by Sandy Baum, an economist at Skidmore College and a leading researcher in the field of student financial aid, shows that median student debt rose 74 percent from 1997 to 2002, to $16,500.

Low-income students have the highest rate of borrowing today, but that's long been true. In fact, their rate of borrowing went up only modestly from 1989-90 to 1999-2000, according to the NCES. It's higher-income students who lately have an increasing propensity for borrowing (see chart).

Chart: Percent of full-time dependent students in public four-year institutions receiving federal loans, by family income quartile

What's more, borrowing might not be quite the devastating act it's made out to be. For example, research suggests that increased loan debt actually has a positive effect on critical matters like enrollment persistence and degree completion, and it is not typically responsible for dropouts. A May 2005 report by the National Center for Public Policy and Higher Education notes that nonborrowers drop out at considerably higher rates in two-year colleges (55 percent vs. 24 percent), and more two-year borrowers go on to earn four-year degrees (21 percent) compared to nonborrowers (6 percent).

For freshmen enrolled in four-year degree programs, borrowers have a slightly lower drop-out rate than nonborrowers and slightly higher rates of continued enrollment and degree completion after six years. Known risk factors for dropping out-poor secondary preparation, working full time, delayed entry to college, attending college part time—"appear to be more important than borrowing in affecting a student's chances for degree completion," the report says.

A 2004 NCES study of completion and persistence rates of the classes of 1994 and 2000 notes that one-half of the 2000 class took out student loans at some point during their college careers and were more likely to stay enrolled than the earlier group, which had a borrowing rate of one-third. "The prospect of leaving college in debt may have motivated these students to stay enrolled and complete a degree," suggests the report.

Nor has higher debt discouraged students from continuing their schooling at the graduate level. The 2002 NCES study of 1992-93 and 1999-2000 grads finds that the rate of continuation to graduate school increased over time, from 16 percent to 21 percent. Even among those not going on to graduate school, the number citing loan debt as a major reason declined considerably from 1997 to 2002, according to Baum's research.

Weighed down by debt?

Students don't appear to be wearing debt anvils around their neck upon graduation either. Despite rising student debt, student loan defaults have declined significantly. In 1990, the default rate was 22 percent. This year, it hit 4.5 percent.

Higher student loan debt is clearly a problem for those who drop out of college—they earn only a small income premium over high school graduates, but the legacy costs of attending college remain, made steeper still by the fact that significant income was likely sacrificed while going to college. Not surprisingly, the highest default rate is among those who do not earn a degree. But among those who do complete a degree, the highest rates of default (approaching 10 percent) occur among borrowers attending two-year colleges and proprietary schools—those borrowers who typically have the lowest debt levels.

Again, it might seem counterintuitive, but some research suggests that heavy borrowing is correlated with low—not high—default rates. A 2003 Texas Guaranteed Student Loan Corp. report shows that the borrowers who have less than $5,000 in student loans default at higher rates than all others, mostly because they have a tendency to go part time and have low graduation levels. A 2002 study in the Journal of Student Financial Aid similarly reports that borrowers with high debt tend to default less often than those with low debt, possibly because high debt is associated with more schooling, and thus higher degree completion rates, which are key to loan repayment.

Financial aid from the Fed

Favorable interest rates have also played a big role in keeping monthly debt payments more affordable than they otherwise would be. Recent students have had the good fortune of taking on loans with interest rates that are a fraction of those in the early 1990s.

The effect is remarkable. The 2002 NCES study of the graduating classes of 1993 and 2000 finds that median loan debt was 74 percent higher in the later group, but average monthly payments were only 24 percent higher. The difference was an interest rate advantage of 2 to 4 percentage points for graduates in 2000. Today's graduates enjoy an even greater rate advantage, with rates reaching the low 3 percent range this summer, setting off a record number of loan consolidations.

Those savings from low interest rates, along with rising graduate salaries, have kept debt burdens (the percentage of monthly income going to pay off loans) generally stable since at least the early 1990s. Median debt burden for the class of 1993 was 6.7 percent, or about $170 of monthly income, one year after graduating, according to an NCES report published this year. Despite much higher total debt, the class of 2000 faced monthly payments of $210, and median debt burden was still only 6.9 percent.

What's more, the ratio of grads with extreme debt ("overburdened" in industry parlance, generally defined as 12 percent of monthly income, though some put the threshold as low as 8 percent) went down for the class of 2000—16 percent compared with 21 percent for the class of 1993. Those in the lowest quartile of salaries also saw their median debt burden drop from 18 percent to 15 percent. The largest increase in monthly debt burden was among those with higher salaries, but their debt ratios were still considered well within range of being affordable. That is, the growth rate of higher-salaried graduates being "overburdened" by debt is increasing, but the absolute rate of overburden is still low compared to those with lower salaries.

Still, not all career fields are created equal. Among those overburdened by debt, the NCES reports that a disproportionate number tend to be in low-paying fields. Borrowers with degrees in business and science/engineering, for example, have lower than average rates of high debt burdens, and those rates declined from 1994 to 2001 (16 percent to 11 percent and 13 percent to 9 percent, respectively). The opposite was true in humanities and social sciences, where rates of debt overburden went from 30 percent to 38 percent, in part because those graduates were also much more likely to borrow more than $25,000.

Those findings are reinforced elsewhere. A 2005 study of Texas A&M student borrowers published by the Texas Guaranteed Student Loan Corp. shows that liberal arts students attending that school had the highest rate of default, and engineers the lowest. Research by Baum in the late 1990s shows that graduates from humanities and arts programs were disproportionately overburdened by debts.

But not all those in lower-paying occupations struggle to pay off college debts. The percentage of students graduating from education programs who are overburdened by debt actually dropped between 1994 and 2001, from 18 percent to 14 percent.

Problems on the horizon?

That's not to say there are no downsides or trade-offs concerning high tuition and rising student debt.

For example, rising prices tend to dampen college attendance by poor students. Part of the problem is that many lower-income students are less willing to borrow for college. A 2005 report by the National Center for Public Policy and Higher Education points out that low-income students fear that borrowing will have long-term and negative financial consequences, particularly if they do not complete a degree. But unwillingness to borrow also pushes students to delay college enrollment, work more than 20 hours a week and/or enroll part time—all known risk factors for dropping out. In other words, many feel that borrowing puts their financial future at risk, when research suggests the opposite might be true.

Even among those willing to borrow, many are intimidated by the sheer complexity of financial aid. A 2005 report by the Advisory Committee on Student Financial Assistance compares applying for financial aid to running a "gauntlet" of obstacles that discourage rather than encourage poor students from entering college. The matter is exacerbated by the fact that high school guidance counselors today have an average caseload approaching 500 students, according to a source with the American School Counselor Association. School districts with low college continuation rates—typically urban and poor districts—tend to dedicate fewer resources to college counseling, when proportionately more are needed to help such students and their parents make decisions in matters unfamiliar to them.

Other controversies and trends are also worth some attention. A slightly larger percentage of students are working, and more of them are working longer hours. Both phenomena are typically attributed to the higher cost of college, and the latter is a formidable obstacle to completing a degree (though part of the trend toward working more appears to be influenced by increasing numbers of employees going to school versus students who also decide to work).

Higher debts appear to be influencing some career choices that might have unwelcome consequences somewhere down the line. For example, Baum and others find that the high cost of schooling in fields like law and medicine has increased the rate at which those grads are overburdened by debt. Not coincidentally, a 2003 survey by the National Association of Student Financial Aid Administrators finds that the proportion of lawyers entering public service law careers after graduation dropped from 5 percent to 3 percent over the last two decades, a trend the association blames on high debt loads of law grads and low starting salaries in public service law. Research also shows that a growing (though still minority) percentage of graduated borrowers are delaying certain activities—like buying a home or car, or having kids—because of college debt.

As more folks go to college, some job-matching problems are popping up, which can complicate the college-as-investment formula. For example, some states (particularly those with high college participation rates, like North Dakota) are starting to pay more attention to the perplexing problem of underemployment—college graduates taking jobs outside their career field, jobs that often don't require a college degree.

More immediately, and ominously, levels of default and debt burden might change significantly should interest rates continue rising, which would push variable-rate student loan rates higher (though many current debt holders are safe, thanks to a surge of consolidation loans at very low fixed rates). Credit card usage has also trended up among students, and it's estimated that as many as one-quarter of students have used credit cards to pay for tuition, though it's unknown whether that's out of convenience, to earn user credits like airline miles, or because of real financial need.

Lastly, an increasing (though still minority) amount of grant aid is being distributed based on merit rather than financial need. Merit-based aid tends to favor higher-income students going to higher-priced schools and has been shown to have little influence on the decision to go to college. As such, it suggests a subtle shift in policy from basic access—making sure a student can go to college regardless of need—to a policy that helps more students go to the college of their choice, regardless of price. (For their part, Pell grants continue to focus on low-income students.)

Dude, still goin'

And still, almost oblivious to tuition hysterics or other related controversies, students continue their march into college. According to a September report, the NCES is projecting that enrollment in public degree-granting institutions will grow by 17 percent from 2002 to 2014, despite the fact that the annual number of high school graduates will grow only 10 percent over this period.

Among the high school class of 2004, exactly two-thirds were enrolled in colleges or universities the following fall, according to NCES figures. That nears the all-time high set in 1997 (67 percent) and is well above the 50 percent continuation rate in the 1970s, when college was supposedly so cheap. Though gaps remain in college enrollment rates by income, those same participation rates have nonetheless risen across the board over the last three decades (see chart).

Chart: Percent of high school completers enrolled in college the October following completion, by income

The reason is mathematically very simple: despite rising costs, going to college still makes enormous financial sense. To wit, policymakers have yet to grasp the simple economic principle of demand inelasticity when it comes to higher education: Students want to go to college, regardless (so far, at least) of higher prices, simply because choosing not to go to college will probably cost them a lot more in the long run in terms of their expected living standard.

Lisa Barrow of the Federal Reserve Bank of Chicago and Cecilia Elena Rouse of Princeton University note in recent research that the college wage premium has risen more slowly of late compared with large wage gains made up through the early 1990s. That's due mostly to the fact that wages of high school grads have been rising since about 1994 after being largely stagnant over the previous decade and a half.

Rising tuition, they contend, remains "a relatively small part of the true total economic cost of attending college." A larger economic consideration is the wages that a student forgoes to attend college. When the full costs of college (including lost wages) and long-term earnings are added up, the authors note, the entire investment in college is recouped within 10 years of graduation. In reality, the period is likely shorter still because Barrow and Rouse use tuition sticker prices rather than net tuition.

Which brings the authors to a final conclusion that might help high school graduates: "It still pays to go to college—very much so, at least as much as ever before."

Ron Wirtz
Editor, fedgazette

Ron Wirtz is a Minneapolis Fed regional outreach director. Ron tracks current business conditions, with a focus on employment and wages, construction, real estate, consumer spending, and tourism. In this role, he networks with businesses in the Bank’s six-state region and gives frequent speeches on economic conditions. Follow him on Twitter @RonWirtz.