Why Private Sector Tuition Has Grown So Much Over Time

The explanation for the explosive growth in private college tuition over time differs markedly from what happened in the public sector.

Although it may be hard to believe today, there have been times in our history when the growth of private sector tuition lagged behind inflation. In the 1970s, for example, tuition growth at private colleges fell below double-digit cost-of-living increases that were fueled by energy-related price spikes.

The current belief that tuition always rises faster than inflation can be traced to the late 1970s when officials at several elite private institutions decided to raise their tuition faster than inflation to catch up for the adverse effects of the 1970s’ hyperinflation. The theory was that the additional tuition revenues would allow them to pay faculty more and upgrade facilities and services. The additional revenues also would allow them to offer more financial aid and thereby boost enrollment of the most economically disadvantaged students.

This ‘high tuition/high aid’ approach worked so well for these leading schools that a broad range of other private institutions bought into the concept during the 1980s. As a result, by the decade’s end, many private schools had boosted their tuition in inflation-adjusted dollars to levels equivalent to those of the early 1970s. Had many of these institutions then tied tuition increases to inflation moving forward, the top private college tuition today would be closer to $40,000 than $60,000 and we might not be having these wrenching conversations about runaway college costs. But instead of scaling back, for the past three decades most private institutions have continued to increase tuition and other charges well in excess of inflation.

To better understand these trends, we must recognize two developments that began in the 1980s and continue today. Each has large implications for private college pricing. One is that federal student loan volume more than doubled in real terms in the 1980s and have continued to grow since then. There has been much discussion over whether easy access to student loans helped to fuel the tuition run-up, or whether rising charges led many more students and parents to borrow more, or some combination of both.

What is clear, however, is that there was a very strong correlation between the growth in tuition and loan volume in the 1980s and that the correlation has continued in the following decades. Also, as tuition kept rising, many came to believe that higher prices equated to higher quality. Dave Breneman, a noted higher education economist, many years ago dubbed this the Chivas Regal effect, the notion that high prices are associated with higher quality. That perception continues today which makes many college officials reluctant to cut tuition if potential customers believe lower prices mean lower quality.

An unprecedented growth in endowments at a number of private colleges was the other key development that began in the 1980s. Endowments are the accumulation of donations of money or property to non-profit organizations — in this case, colleges and universities — which they then use the resulting investment income for specific purposes. In many ways, higher education endowments are uniquely American as they grew out of the fact that private colleges were the first institutions in this country. This is unlike most other countries around the world in which higher education began in the public sector and continue in that way.

Colleges and universities use the income from endowments and annual gifts for two principal purposes — to keep prices below what it costs of provide a higher education or to provide financial aid to students whose families cannot afford what was being charged or who merited financial aid for a variety of reasons. For most of our history, endowments were relatively modest for all but the wealthiest colleges and the income was used mostly to suppress tuition below costs by endowing faculty chairs and by other means.

But the size and the role of endowments has changed significantly since the 1980s for some private colleges and universities as their endowments have radically grown and how these funds are used has changed.

Most private institutions continue to have limited endowments and largely depend on tuition revenues to pay their bills. In adopting a high tuition/high aid strategy in the 1980s and beyond, these institutions ‘paid’ for student aid by providing tuition discounts from the full sticker price. They can stay in business or even thrive at current price levels if the tuition revenues net of discounts fully meet their budgetary needs. They could reduce tuition IF the decrease in tuition minus discounts is used to fill seats that otherwise would be empty or changes the mix of students to include more who can pay all or most of the bill. Another possible successful tuition-cutting strategy for institutions with little or no endowment would involve cutting spending per student to arrive at a more sustainable budget.

The situation is different for the 100 institutions with endowments of $1 billion or more — they use their endowments for two purposes. One is indeed to fund discounts for students who cannot afford the sticker price and/ or who are deemed to merit financial assistance. But these endowments are also used to endow faculty chairs, subsidize operations, and finance major capital projects. In fact, at most private institutions with endowments, income from endowment and annual gifts is used more for these kinds of activities in the universities’ budgets than to provide student financial aid discounts.

The situation is different still for the 50 institutions with $2 billion of more in endowments and the dozen that have at least $10 billion in endowments. For these very well-endowed institutions, tuition and fee increases relieve pressure on endowments to subsidize tuition but puts more pressure on them to meet financial need of their students. Conversely, freezing or reducing tuition for these institutions requires the endowment to be used more for tuition suppression and less for student aid discounts. The increase in the amount of endowment used for either purpose could be accomplished by increasing the payout from endowment.

It’s worth asking how endowments have grown for the 100 institutions with a billion dollars or more in endowments. For the most part, they all were part of the trend of tuition increasing at twice the rate of inflation or more. Most of them have also mounted enormous fundraising campaigns and employed aggressive endowment management techniques. The one way in which most private institutions have not been so aggressive is in how much they draw from endowments. Payout rates are often pegged below 5 percent, less than what their endowments historically have earned over a long period of time.

As a result, these private institutions have been able to increase their spending levels and a score of schools have built up endowments to levels previously unimaginable, raising questions about whether they can rightly continue to be considered charitable institutions. In effect, these record high endowment levels reflect the decision of board members and officials to protect the interest of future generations of students at the expense of current students, many of whom must pay prices that are unaffordable now without enough financial aid, often forcing them and their families to rely heavily on loans.

Another recent trend is that fundraising appeals at many institutions tend to be focused on asking donors to specify that their gifts will be devoted to student financial aid. This focus on using endowments to pay for financial aid fails to acknowledge that one of the primary uses of endowments is to suppress what is charged below what is spent by endowing faculty chairs, subsidizing operations and helping to offset the costs of research not funded by other sources. The fact is that at most institutions with sizable endowments, the amount devoted to keeping tuition below spending per student continues to be far more than the amount devoted to financial aid.

The recent focus on using endowments to fund financial aid seems to have led many private college officials to believe that the only way to achieve greater diversity on their campus is to raise tuition to pay for more financial aid for needy students. But this view ignores the arithmetic reality that limiting tuition for all students also relieves the pressure on institutions to provide more discounts because needy students would require less aid to fully meet their need. Restraining the growth of tuition revenues net of aid also can have the beneficial effect over the long term of limiting how much institutions spend on other things that may not be central to the school’s core mission.

The fundraising focus on financial aid also fails to recognize that when tuition continue to increase faster than parents and students can afford to pay, that puts added pressure on the endowments to provide more and more financial aid in order to keep up with the growth in tuition and other charges. With every dollar increase in tuition, 50, 60 cents or more must be devoted to financial aid discounts in order to just stay even. Conversely, keeping tuition growth in better check or reversed as a way to relieve pressure on endowments to carry the full burden of advancing the equity agenda.

The COVID-19 pandemic has several critical implications for private colleges in this country. The most obvious one is that endowments at most institutions have taken a substantial hit — declines in value could easily be 25 percent or more by the time this crisis has run its course. Thus, the numbers cited above will change substantially when new figures are available.

But going forward, the key question is how will well-endowed institutions react to these changes in their wealth on paper. Will they devote more of their funds to financial aid to take into account the changing circumstances of their students and their families? Or will they decide to slow or reverse the growth of tuition and other charges to make themselves more affordable to a broad range of families? They could do this by reducing their spending and/or paying out more from their endowments. A subsequent blog will examine these questions in greater detail.

Art Hauptman has been a public policy consultant specializing in domestic and international higher ed finance issues for nearly a half century.

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