All posts by Daniel Bennett

Daniel L. Bennett is a Research Professor at the Baugh Center for Entrepreneurship and Free Enterprise at Baylor University.

The College Endowment Tax: A Good Idea, Sort of…

Starting next January, some 35 very wealthy private colleges and universities will start paying an annual 1.4 percent college endowment tax under the new tax reform law. That’s very few of the nation’s institutions of higher learning, and the tax will not apply to assets that directly contribute to an educational purpose. When you hear wisecracks such as “Harvard is a hedge fund with a university attached,” you are listening to one reason for the tax. Other reasons include resentment toward elite universities for allowing leftwing domination of modern faculties and rising campus disrespect for free speech and intellectual diversity.

Related: The Case for Taxing Endowments

The precedent to exempt colleges from taxation emerged during the colonial era when newly established colleges were subsidized, in part, by exempting them from property taxes. Given their mission to educate young men for civic leadership and the clergy, the employment of an infant industry policy to exempt colleges from taxation to encourage their growth and sustainability seemed reasonable. Colleges, however, are increasingly astray from the mission of creating and disseminating knowledge, which serves a useful social function that arguably merits subsidization. They are increasingly engaged in revenue-generating activities that resemble those pursued by taxpaying commercial enterprises.

This includes endowment investment portfolios at some universities that look like highfalutin hedge funds. The commercial interests of universities should be taxed in the same manner as taxpaying enterprises and individuals, not granted the special privilege. The endowment tax moves us closer to this ideal.

The endowment tax mainly applies to wealthy universities such as Harvard, MIT, Princeton, and Yale. These four institutions collectively control about a quarter of the $500 billion assets held by college endowment funds, providing them an unprecedented advantage in attracting top students and faculty. The tax may reduce endowment inequality and improve the competitiveness of higher education. Some donors may redirect their philanthropy from the wealthy institutions to less well-endowed ones where their gift will have a higher long-term impact because it will grow tax-free. This would improve the financial position of institutions benefiting from such reallocation of gifts, allowing them to invest in strategic areas to better compete for top students and faculty.

Finally, the endowment tax may send a symbolic message to colleges that the public is increasingly dissatisfied with their behavior. Lawmakers with the ability to subsidize colleges also have the option of taxing them. This could serve as an impetus for university leaders to control profligate spending, improve affordability, enhance learning, and promote intellectual diversity.

Will It Reduce Financial Aid?

Some college officials have suggested that the endowment tax will reduce access among talented low-income students because a portion of their endowments is earmarked for financial aid. Returns attributable to such funds may end up exempt as an argument could be made that scholarships directly contribute to an institution’s educational mission.

While the endowment tax will nonetheless result in a modest revenue loss for wealthy institutions, most of these schools have what economists refer to as highly inelastic demand curves. This means they could raise tuition without significantly reducing the number of qualified students willing and capable of paying sticker price. The loss in revenue from the endowment tax could be made up by charging full price payers more, without adversely impacting access to low-income students. Proponents of redistribution should favor this. But then again, affected colleges might respond by reducing the number of low-income students admitted or the aid packages offered to them.

The endowment tax of 1.4 percent is lower than the 2 percent rate imposed on net investment income of private foundations. Meanwhile, individual investment income is taxed at the marginal rate (up to 37 percent post-reform) and long-term capital gains up to a 20 percent tax rate, plus any state levies. The net investment income and capitals gains of corporations are taxed at the corporate rate (21 percent post-reform). Why should wealthy universities such as Harvard, whose $37 billion endowment exceeds the GDP of countries such as Bahrain and Latvia, pay a lower tax rate than a middle-class family or small business for performing the same economic activity?

In addition to the direct revenue loss from the endowment tax, the new policy will also impose indirect costs. The higher education community is likely to increase its lobbying efforts to try and shape the final details of the policy in their favor to minimize losses. The policy will likely be complex, imposing new compliance costs. Lobbying and regulatory compliance are costly and will divert resources from more productive uses.

A Small Tax Needn’t Stay Small

Though the new tax is small, we should learn from history. The Revenue Act of 1913 imposed a very modest 1 percent federal income tax but has evolved into the federal government’s largest revenue stream, propagating a Leviathan central government.

While the endowment tax is likely to have a modest impact, it is a slippery slope for further federal meddling in and politicization of higher education. Faced with a rapidly expanding national debt and unfunded liabilities, lawmakers may view universities resources, including their endowments, like a pot of gold at the end of an ivory tower. They may also increasingly use the power of the purse to coerce university conformity to whatever ideology is in vogue, further reducing intellectual diversity.

Federal intrusion into higher education has been a root cause of many of the issues fueling growing public resentment towards it. Calling upon the government to fix problems that it helped create may prove to be foolish and perpetuate them indefinitely. As Milton Friedman once said, “there is nothing so permanent as a temporary government program.” His wisdom suggests that we ought to move in the direction of reducing government involvement in higher education, not increasing it.

Another Bad Idea–Mandatory Endowment Spending

School is back in session but not much has changed in the world of higher education. Tuition continues to become less affordable, student debt continues to rise, and students increasingly face poor career prospects. Also resuming is the barrage of policy proposals claiming to offer silver-bullet solutions to all that ails higher education.

The latest idea to make news headlines is a plan to force institutions with endowment assets exceeding $100 million to spend at least 8% of their assets each year. Writing for the New York Times, Victor Fleischer claims that under his proposal, “the sky-high tuition increases would stop, and maybe even reverse themselves. Faculty members would benefit from greater research support. University libraries, museums, hospitals and laboratories would have better facilities…Only fund managers would be worse off.”

Not Every Campus Is Yale or Harvard

While institutions such as Yale, Harvard, MIT, Princeton and Stanford are very richly endowed, with assets topping $10 billion apiece, most institutions are not nearly as financially blessed.

According to IPEDS data, only 397 universities with an undergraduate enrollment of at least 1,000 students had an endowment exceeding $100 million at the end of FY2013. While the average endowment among these schools is nearly $1 billion, two-thirds of the institutions had assets of $500 million or less, and the vast majority (81.6%) had assets under $1 billion.

Endowment chart

While these may sound like sufficient sums to fund utopian transformations of campuses, recall that the plan would only require institutions to spend 8% of their endowment annually. This would amounts to an average of more $13,000 per undergraduate student enrolled at these institutions. Viewed in this light, mandatory endowment spending could significantly reduce tuition and/or enhance the quality of education and knowledge discovery.

The distribution of endowment assets is highly skewed, however. Among the 324 institutions with an endowment below $1 billion, the 8% spending requirement would provide, on average, an additional $6,200 per undergraduate student. For institutions with an endowment under $500 million, it would amount to around $5,000 per undergraduate. These are still significant figures, but for more than 10% of the schools subject to the policy, it would amount to less than $1,000 per undergraduate. Institutions such as University of Central Florida, Miami Dada College, and Liberty University would only have about $200 per undergraduate.

Not a Panacea

While coercing universities to spend 8% of their endowments annually would boost university operating budgets significantly, on average, doing so is not a panacea.

Under the rule, the most richly endowed universities would be forced to spend more, but these institutions already have highly paid faculty and staff, top-notch facilities, and charmingly elegant campuses. And judging by the demand for admission to these institutions, they should arguably increase their tuition instead of lowering it. Furthermore, these elite universities are hardly those that policymakers and the general public have in mind when considering policies aimed at improving quality and making college more affordable.

As described above, many institutions subject to the rule would derive less than $1,000 per student under the policy. This would hardly be sufficient to implement the game-changing tuition reductions and other improvements prophesied. Furthermore, private foundations are only required to spend 5% of their endowment assets annually, so why should universities be subject to a higher rate? Thus, any policy change in this direction would likely generate a significantly smaller increase in operating budgets than reflected in the above estimates.

Unintended Consequences

Mandatory endowment spending would undoubtedly enhance short-term operation budgets, but it would also generate a number of unintended and potentially undesirable long-run consequences. Looking beyond the less-than-full pot of gold at the end of the rainbow, there are a number of reasons that an endowment spending mandate is bad news.

First, we should not expect that the operational budget enhancements would be utilized to control or lower tuition. When provided with additional revenues, universities have no problem spending the money on things that neither enhance educational quality nor make college more affordable. Witness the increasing bureaucratization of universities and the transformation of college campuses into country clubs, attributable in large part to the rapid growth of federal student assistance programs. Intended to make college more affordable, federal aid has instead driven up the cost of college, as confirmed in a recent study by Federal Reserve Bank economists. Transferring endowment resources to university administrators will likely yield a similar result –profligate spending that drives up the cost of college.

Donors increasingly take caution to ensure that their gifts are utilized in a manner that they desire. Major gifts are often designated to perpetually fund student scholarships, faculty chairs, or educational programs. The spending mandate would violate the intent of many donors who gave generously in order to provide a long-term revenue stream for such programs. Spending down such designated gifts would not only undermine the long-run solvency of endowed programs, but it would constitute the violation of a slew of (at least implicit) contracts.

A barrage of lawsuits is likely to follow in the wake of the widespread violations of donor intent. This would entangle both university and private resources in expensive litigation, diverting resources that could otherwise be available to fund scholarships and invest in other educational programs.

Such a policy would also create uncertainty on the part of prospective and future donors concerning the use of their philanthropic gifts, potentially increasing the degree of caution that philanthropists take before gifting their assets. Thus an endowment spending mandate would undermine the development efforts of many institutions, making it more costly to raise funds from private donors.

If You Can’t Beat  ‘em, Tax ‘em

Responding to Fleischer, Alexander Holt indicates that “universities seem to be acting very similarly to corporations, and his solution is to force them to act less like one….Colleges act like corporations and they should be treated as such.” In other words, Holt suggests that universities are engaged in many of the same ventures as tax-paying private enterprises, and as such they should be subject to the corporate income tax. This is not a new idea, but it is a good one, particularly for well-established institutions highly invested in ventures traditionally operated by tax-paying businesses. Such university ventures should be subject to the same tax rules as the businesses that compete with them. We should also consider limiting the tax deductibility of university gifts to those designated for scholarships and research and educational programs. But forced endowment spending, No.

Federal Meddling Costs Vanderbilt $150 Million a Year

A study by Vanderbilt suggests that the university spent $150 million complying with federal regulations during 2013-14.  Although the details of how Vanderbilt arrived at these alarmingly figures have yet to be released, they should nonetheless be viewed as additional validation that the federal government’s overweening supervision of higher education is making college less affordable for students and their families. Most people would likely agree that making college more affordable is a good objective and the best way to achieve this is to get the government out of the higher-education business altogether.

Growth of Federal Regulations

According to the Mercatus Center’s RegData, the number of restrictions or obligations placed on colleges and universities by federal regulations increased from around 430,000 in 1997 to nearly 583,000 in 2012, an increase of more than 35 percent. This makes higher education one of the most heavily regulated sectors of the economy –only insurance brokers, architects and engineers, and oil and gas extractors face more regulatory burdens and obligations.

A recent report of the Task Force on Federal Regulation of Higher Education, prepared by the American Council on Education, suggests that the Department of Education (DOE) has been engaged in regulatory overreach, as many of the regulations that it has imposed have been executed by fiat. In 2010 for instance, DOE by its own volition mandated that a credit hour be universally defined by seat time.

The department also controversially altered the gainful employment regulation governing vocational programs in 2011, a rule that was struck down by a federal court as arbitrary before it went into effect. Despite the early judiciary setback and the House of Representatives’ staunch disapproval of further regulation, the DOE pressed on with its aggressive regulatory agenda and in 2014 passed a nearly 950-page gainful-employment rule.

The federal government also increasingly imposes regulations on colleges and universities virtually unrelated to educating students, protecting them or providing accountability for the proper use of taxpayer dollars. The Task Force report highlights several regulations of this sort, such as burdening colleges with verification that males are registered with the selective service, distributing voter registration forms, and informing students about laws concerning illegal filing sharing.

DOE also increasingly acts as an unconstrained and unaccountable rule-making body, imposing regulations through sub-regulatory guidance–a process that not only lacks Congressional approval but is also executed without a public-comment period. Such regulations are often enacted through “Dear Colleague” letters or emails. The DOE issued 270 of these letters in 2012, about one per working day.

Costs of Regulation

Vanderbilt is not the only institution that has attempted to estimate its cost of regulatory compliance. Stanford University estimated that it spent $29 million to comply with regulations in 1997. Hartwick College estimated that is spent nearly $300,000 to comply with regulations in 2011-12. Although the cost estimates differ substantially, all three of these institutional studies suggest that regulatory compliance costs amounted to 7-11 percent of their annual expenditures.

Among the 7,022 colleges and universities with expenditure data in IPEDS, the average institution spent $72 million in 2013-14. Conservatively assuming that regulatory compliance amounts to 5 percent of expenditures, the average institution spent $3.6 million to comply with regulations, putting the total regulatory cost of the sector at $25.3 billion.

Let’s put this back-of-the envelope estimate of the regulatory costs in perspective. The total cost burden is equivalent to the size of the economy in Vermont or Equatorial Guinea. These costs significantly affect each student, amounting to about $1,200 per student, or approximately 15% and 9% of the mean enrollment-weighted tuition fees set by public and private 4-year instructions, respectively.

Making College More Affordable

Federal red tape imposes real costs on colleges. The burden of these costs is almost assuredly passed on directly to students in the form of higher tuition fees, given that most economists believe the demand for college education is relatively inelastic, meaning that consumers are not very responsive to price increases.

Growing awareness of this alarming trend is likely to prompt people to point fingers at the DOE, as discussions grow louder over college costs. Indeed, the Task Force report cited above is a step in this direction, calling for greater constraints to be placed on the Department of Education, more transparency in the regulatory process, and a reduction in regulatory burden. Such reforms, which would be an improvement over the existing system, do not address the root of the problem and are akin to rearranging the deck furniture on the Titanic.

A significant amount of the regulatory burden is tied, either directly or indirectly, to the federal student aid programs. Indeed, the growth of higher education regulations has accompanied the growth of federal financing of student tuition. According to the College Board, real total federal aid expenditures amounted to $60 billion in 1997-98, a figure that nearly tripled by 2012-13, reaching $171 billion. The Mercatus regulatory data mentioned above suggests that the number of higher education regulations increased by 35% over this time period.

Colleges love the flow of taxpayer money stemming from the federal student aid programs, but they hate the strings attached in the form of regulations. Lying in bed with the beast is hardly cost-free. And colleges have certainly not been saintly stewards of taxpayer money. A recent report from the Federal Reserve Bank of New York is the latest study to provide evidence in favor of the Bennett Hypothesis (named for former Secretary of Education William Bennett) that federal student aid incentivizes colleges to raise tuition.

The only viable long-term solution to make college affordable is to get the federal government out of financing higher education and allow the free market to do its work. This will reduce the justification for regulating colleges, reducing these costs. It will also reduce the perverse incentives for colleges to increase tuition to capture more revenues. Additionally, it will create a more competitive and innovative higher education sector, making college more affordable for millions of students.

More Government, More Bad Student Loan Policy

Congress recently approved a bill to fund the government for the remainder of the fiscal year. It cuts Pell Grant funding 1.3%, from $22.8 to $22.5 billion.  This reduction in the needs-based grant program will be reallocated to student loan service providers such as Navient and Nelnet, a move orchestrated by outgoing Senator Tom Harkin. This follows a policy enacted earlier this year by the Obama Administration to increase payments to loan servicers.

The justification given for the increasing funding is to encourage better customer service. Service providers have recently been criticized for a number of improprieties, including overcharging veterans, mistreatment of distressed borrowers, and failure to prevent borrowers from defaulting. The reallocation of Pell funding to these providers is like punishing one prisoner for good behavior and releasing a violent criminal early for assaulting prison guards.

End of Year Burn-Downs

The Pell Grant is a politically popular program, receiving widespread support from both sides of the aisle. As a discretionary budget item, Pell funding was targeted for a cut because it currently has a surplus. Government programs experience a surplus when appropriations exceed expenditures. Surpluses signal to lawmakers that more taxpayer funding was allocated than was needed for operation, creating pressure to subsequently reduce funding and reallocate it to programs without a surplus. Economic theory suggests this mechanism will incentivize directors to avoid fiscal prudence and instead be spendthrift. As a former federal contracting official, I have experienced the end of the fiscal year burn-down. Overtime was encouraged and cost-benefit analysis for purchases discouraged.  This promotes the inefficient provision of goods and services that are disconnected from the preferences of taxpayers.

Surpluses are called profits in the market sector.  Profits signal that consumers highly value a firm’s products and attract additional providers, enhancing competition that exerting downward price pressure. With profits, firms either:  distribute them to owners; save them for a rainy day; or re-invest them to improve product quality, lower production costs, or enter new product markets.

Surpluses in the market sector enhance consumer welfare. Not so much in the government sector.  Rather than allowing the Pell surplus to be saved to offset expected future program shortfalls, funding for the popular program is being reallocated to further subsidize allegedly unscrupulous loan servicers.

                          Rewarding Bad Behavior

Allegations of malfeasance by subsidized loans servicers are to be expected. Similar allegations were directed towards subsidized loan originators prior to the 2009 federal takeover of the student loan industry. Public policies that privatize profits and socialize losses create perverse incentives. They enable subsidized firms such as loan servicers to reap the rewards of signing up borrowers and capturing the taxpayer-funded fees for “serving” them without facing consequences for providing poor service.

These government-granted oligopolistic firms have little incentive to treat customers with respect and provide them with good service. Borrowers have little recourse –they cannot vote with their wallets as they can in a pure market setting.  Borrowers have the option to pursue costly lawsuits or organize politically to attempt to institute change. Both are highly inefficient methods that are often futile because of the cozy relationship between government and the crony servicers.

In response to allegations of customer abuse, President Obama declared earlier this year: “We’re going to make it clear that these companies are in the business of helping students, not just collecting payments, and they owe young people the customer service, and support, and financial flexibility that they deserve.”  Recent changes to contractual arrangements between Department of Education and loan servicers are intended to “strengthen incentives for them to provide excellent customer service and help borrowers stay up-to-date on their payments.” The plan is to dangle more money in front of poorly performing loan servicers such as Naveint in hopes of pushing them to perform better.

Perverse Incentives

This is analogous to arguments that the 2009 fiscal stimulus would have promoted a robust recovery had more than $787 trillion been allocated towards politically favored projects. The problem is not the size of the payments, but the perverse incentives created by highly distortionary political resource allocation.  Poor customer service and abuse by loan servicers is not a market failure in need of correction by government policy. It is a problem created by government intervention in an industry that would function better in a free market environment. The government should not be in the student loan business –not as lender, contractor of service provision, or subsidizer.  Until government withdraws from this market, expect to continue hearing horror stories of students marred in debt and treated with the same level of customer disservice provided by the DMV.

How To Fix the Skills Gap

It’s definitely true, as Tom Friedman recently noted, that many graduates don’t possess the skills that today’s employers seek.  Thankfully, some colleges have taken notice. They’re trying to address the skills gap either by boosting faculty-student mentorship programs or partnering with employers to better prepare students for the workforce.  Fortunately, these ideas aren’t mutually exclusive. Moreover, they don’t require the sort of government involvement that Friedman recommends.

Continue reading How To Fix the Skills Gap

A Faulty Attack on For-Profits

Senator Tom Harkin continued his relentless attack on for-profit higher education this week by releasing a report condemning the sector. Specifically, Harkin laments for-profits’ success in enrolling military veterans and earning their Post 9/11 GI Bill revenues. Despite federal efforts to slow the sector’s growth, it successfully enrolled 31% of all veterans in 2012, up from 23% in 2009. Meanwhile, the public college market share of veterans declined from 62 to 50% over the same period. So why are veterans increasingly choosing to attend for-profit college over public ones? Harkin blames the profit motive, which he believes leads for-profits to use aggressive marketing tactics on naïve veterans.

Harkin’s argument is mistaken for two reasons. First, he appears to question the decision-making capability of many of our nation’s military personnel, all of whom also voluntarily chose to enter the service prior to choosing to enroll in college. If these men and women were capable of making the decision to risk their life joining the military, they are also capable of choosing a college study program and institution that best suits their needs. One of the best attributes of the U.S. postsecondary education market is that it is very diverse, so our veterans have a wide array of offerings to choose from, including vocationally-oriented for-profit colleges. Harkin wants to limit that choice.

Second, while some myopic administrators may pursue the veteran’s tuition benefits at all cost, including the reputation of their institutions, this is likely an exception rather than the rule. Like other investors, educational entrepreneurs invest substantial time and capital when they believe a long-term profit opportunity exits. That such an opportunity exists suggests that our nation’s traditional colleges are failing to serve the diverse educational needs of an increasingly nontraditional student population such as military veterans. Indeed, veterans increasingly attend for-profit institutions because they offer the right mix of study programs, customer service, and locations and times that meet their needs better than do public college.

Continue reading A Faulty Attack on For-Profits

A Smarter Way to Regulate Colleges

Colleges are cashing in credential inflation. In a recent essay for The Chronicle of Higher Education, Kevin Carey notes that many “not-for-profit” colleges operate highly profitable terminal master’s programs in fields such as business administration, education, and public administration that are indistinguishable from the two-year vocational offerings of most “for-profit” colleges. He therefore argues that profitable non-profit programs that offer insignificant financial aid should face the same set of regulatory and tax rules as profit-seeking colleges. Carey is correct that schools create professional programs largely to make money. However, only regulating those programs that provide insufficient resources to their students is a band aid for a problem that requires major reconstructive surgery.

Continue reading A Smarter Way to Regulate Colleges

When Did Federal Intervention in Higher-Ed Begin?

The conventional wisdom among higher education historians is that government was uninvolved in the development of American higher education before the Civil War. In “Myth Busting: The Laissez Faire Origins of American Higher Education,” published recently in The Independent Review, I refute this view using a framework that compares the actual political economy during the period against a true free market for higher education. My analysis suggests that the sector was not free from government intervention, but rather the state was considerably more involved in shaping the trajectory of American higher education than most scholars proclaim.

What constitutes a true free market for higher education? The criterion that I use involves three broad features: property rights and institutional autonomy, privatization, and competition.

Prior to the 1819 Supreme Court ruling in Trustees of Dartmouth Coll v. Woodward, the property rights and autonomy of colleges were increasingly threatened by politicians seeking to control them. The ruling in the case is widely viewed as institutionalizing the property rights and autonomy of colleges, providing an impetus for a proliferation of private colleges.

While the majority of colleges that emerged during the era were founded by private interests, this does not necessitate the existence of a private and competitive market. Many so-called private institutions were subsidized with land, cash, and/or regulatory protections that provided them with a competitive advantage relative to institutions that were either philosophically opposed to government intervention, or were unsuccessful rent-seekers. And many institutions received an exemption from property taxes, a policy that largely remains intact today but has recently been questioned.

Although many credit the rise of the public sector to the Morrill Land Grant Acts of 1862 and 1890, these policies were essentially scaled-up versions of antebellum state and federal policies. The original constitutions of several states called for the establishment and financial support of state institutions, and revenues were often raised through the sale of land. The federal government’s first endeavor with land grant colleges was the Northwest Ordinance of 1787, which called for the creation of a university using proceeds from the sale of land.

Discriminatory subsidization of colleges and the creation of state institutions hardly constitute a private and competitive higher education marketplace. Instead, these state interventions altered the natural market process that would have evolved in their absence. Given that American higher education today is massively subsidized, heavily regulated, and subject to extensive rent-seeking, it seems likely that these developments are at least partially attributable to state interventionism during the sector’s infancy. The traditional view that it was not seems to be propagated by a misunderstanding of the market process.

Obama’s Higher-Ed Plan Asks for More Government Control

The White House yesterday unveiled what it is billing as an ambitious new plan to tackle college affordability. President Obama’s wish list amounts to an expansion of centralized state control over higher education, containing a hodge-podge of special-interest items masqueraded as reform

First is a government college ranking system to be based on measures of access, affordability and outcomes. Obama hopes to have this system online by 2015 and use it to distribute differential student aid levels by 2018. Students attending colleges with more low-income students, lower tuition and debt levels, higher completion rates, and more successful graduates would be eligible for larger Pell Grants and more favorable loans. Several problems jump out to me. The private sector already offers myriad college rankings systems and does so efficiently. The Forbes-CCAP college rankings provide many of the outcome-based metrics proposed by Obama, so the government system would provide very little marginal value in terms of consumer information, notwithstanding the unlikely circumstance that student records are matched to IRS earnings data. The system as described will favor public colleges because government regulators will fail to account for subsidies such as cash transfers and tax exemption in their comparison of average tuition and debt levels.

Next is a race to the top for higher education, intended to promote competition among the states to offer innovative solutions to college affordability and completion. This is essentially refurbishment of a K-12 policy that has resulted in little more than rewarding individual states for promising to spend more. The beauty of federalism is that it provides a laboratory for policy experimentation. As the President’s agenda indicates, several states (Tennessee, Indiana and Ohio) are already pursuing performance-based funding. If these states experience success, then it is a matter of time before similar policies spread to the other states. Better to allow this to happen organically than for the federal government to push yet-unproven policies.

Obama wants to make all student loan borrowers eligible for income-based repayment, which would cap monthly payments at 10% of income. This will do little to incentivize institutions to manage tuition inflation. Students will be encouraged to take out larger loans without the commensurate risk assessment of not earning enough to repay them, effectively transferring this risk to the taxpayer. Further, IBR favors public-sector workers with shorter repayment periods. Better to let the private sector handle student lending and for government to focus on funding well-qualified, low-income, credit-constrained students.

Obama calls for greater use of technologies such as MOOCs and competency-based degrees. The biggest barrier to technologies becoming more widespread is not a lack of entrepreneurship or student interest, but the regulatory apparatus in place that assigns the accrediting agencies a central role. These private associations are comprised of college officials that serve the interests of their members. They have served as a barrier to innovation and competition in higher education since gaining gatekeeper responsibilities in the mid-20th century. Regulatory reform needed to unleash creative destruction requires a complete overhaul, not tinkering around the edges with special exemptions and government serving as a crony venture capitalist.

A White House blog describes college education the ticket to the middle class. With rising student debt levels and underemployment becoming the new norm, aided by federal efforts to stimulate demand over the past several decades, perhaps the proper analogy is that it is a lottery ticket to the middle class. If past experience is any indication, growing federal involvement in higher education will exacerbate tuition inflation without a corresponding improvement in quality or outcomes. Better would be to pursue market-based reforms that lessen reliance on the government.

Crony Capitalism at the Department of Education

My colleague Richard Vedder once described former Undersecretary of the Department of Education Robert Shireman as “the only guy I ever met whose very appointment to public office destroyed hundreds of millions of dollars in wealth.” Of course, Vedder was referring to the rapid devaluation of publicly traded higher education firms’ stock prices that followed Shireman’s appointment. Investors feared Shireman, who, as the founder of the Institute for College Access & Success (TICAS), advocated for stricter regulations on for-profit colleges and nationalization of the student loan market.

They were right to worry. Shireman’s enhanced scrutiny of the for-profit sector resulted in an $8 billion loss for investors of the 13 publicly-traded for-profit institutions during the second half of 2010. The for-profit seeking sector and its investors were particularly concerned over the ED ‘s efforts to enhance regulations through “gainful employment” rules that would withhold  federal student aid from for-profits that did not satisfy highly subjective metrics. However, the eventual rules that emerged were weaker than anticipated, prompting a rise in stock prices for the education stocks; moreover, last summer a judge struck down the rules, deeming them “arbitrary.”

Shireman’s behavior in implementing these regulations is now under scrutiny. The ED inspector general is investigating whether Shireman violated a conflict of interest agreement by improperly disclosing governmental discussions to TICAS and select individuals in the investment community prior to public disclosure. One such individual is Diane Schulman, a stock analyst whose circle of industry friends is believed to include short-seller Steve Eisman. Shireman faces potential civil and/or criminal charges if the allegations are confirmed.

The government should broaden its investigation. One group that has likely benefited during this debate are hedge fund traders such as Eisman, who may have advocated tougher regulation of the sector for his own benefit and has possibly received insider information from ED officials and politicians. Though the SEC investigated Eisman’s former firm FrontPoint for insider trading, to my knowledge, no one, is investigating  the potential Eisman-for-profit scandal, despite several prominent federal watchdogs advocating for one.

Both Karl Marx and Joseph Schumpeter predicted that capitalism would eventually falter. Marx assumed that that people would eventually succumb to the allure of socialism as a means to improve their lives. Recent history does not bear out his prediction. Schumpeter’s prophesy, on the other hand, was based on the idea that capitalism would falter because its foremost beneficiaries would eventually cease to defend it. The spout of crony capitalism surrounding ED policy is but one example of the rising tide of cronyism that might prove him right.

The Beltway For-Profit Witch Trials


In mid September, the Congressional duo of George Miller and John
Tierney joined their Senate colleagues Tom Harkin and Dick Durbin and the
Department of Education in what might be described as the ongoing Beltway Witch
Trials, where the alleged witches are the colleges that are legally organized
on a profit-making basis. Messrs. Miller and Tierney proposed a new line of
assault to rein in these alleged evil doers that they have creatively named
the College
Student Rebate Act of 2012
. The objective of the proposed
legislation is to exert political control on how private sector colleges
allocate their financial resources, as the bill calls for a cap of 20 percent
for expenditures on “advertising and promotion activities, excessive
administrative expenses including executive compensation, recruiting, lobbying
expenses, or payments to shareholders.” Expenditures on these activities
exceeding the cap would need to be refunded to students and/or the government.

Rep. Miller told the Huffington
that since “for-profit colleges tend to get a great deal of
revenue directly from the federal government…how schools spend this money must
be carefully examined.”Examination is one thing, but what the bill would really
do is enable politicians and unelected bureaucrats to limit the ability of
private firms to attract customers and strengthen their brands, compensate
their managers for successful performance, protect themselves from additional
onerous regulations, and reward owners for their investments. The bill would
seriously inhibit the incentive structure necessary to promote private investment,
innovation and growth in an industry greatly in need of improved efficiency. 

Continue reading The Beltway For-Profit Witch Trials

What Will They Learn? Maybe Not Much

Academically Adrift“, a study by two sociologists – Richard Arum of NYU and Josipa Roksa of the University of Virginia – demonstrated that 36
percent of our college students graduate with little or no measurable gains in
their core academic skills – areas like expository writing and analytical
reasoning.  Their diplomas are literally tickets to nowhere.  No, I
take that back.  With an average student debt of $25,250, they are tickets
to long-term financial crises that can curtail their opportunities for

The higher education establishment assures us that this
poor showing is due to the underfunding of colleges. 
Not so.  The average per-pupil expenditure on higher education in America is
more than twice the average of other industrialized nations.  No, the
problem is not too little money.  It is too little attention to what
matters.  What do students learn during those expensive college years?

Continue reading What Will They Learn? Maybe Not Much

Gainful Employment: A Detriment to Competition


Today the Obama Administration unveiled its long-anticipated and highly controversial final gainful employment (GE) regulation  that ties program eligibility for federal student aid to new metrics that are based on student loan repayment rates. Under the new GE rule, a vocational program can qualify as leading to gainful employment and remain eligible for federal aid if one of three metrics is met:

1.     At least 35% of former students are repaying their loans;

2.     The estimated annual loan payment of a typical graduate does not exceed 30% of discretionary income;

3.     The estimated annual loan payment of a typical graduate does not exceed 12% of total earnings.

The rule requires that a program fail to meet one of the three metric three times in a four year period before becoming ineligible for federal student aid, with 2015 being the first year that a program can lose eligibility. Education Secretary Arne Duncan defended the metrics as a “perfectly reasonable bar…that every for-profit program should be able to reach. We’re also giving poor performing for-profit programs every chance to improve. But if you get three strikes in four years, you’re out.”

Continue reading Gainful Employment: A Detriment to Competition

Another Pitfall for Student Loans

In a recent article for Career College Central, I discuss the negative implications of the Department of Education’s (ED) proposal to alter the gainful employment rule to restrict the amount of money that a student could borrow by program of study and expected entry level occupational earnings. I identified three major flaws with the proposal. First, it would severely limit the ability of for-profit colleges to offer bachelor’s degree programs, and other non career-specific fields of study. Next, it fails to account for total compensation, regional variations in compensation, and the possibility that workers will receive a promotion or pay increase over time. Finally, the rule could result in a reduction of educational options and access for those most in need, and a shortage of qualified employees to meet the demands of the labor force.
I also analyzed the effect that the rule would have on 10 occupations that are expected to produce more than 2.6 million additional jobs by 2018, finding that for most of the occupations, students would have been able to borrow less (after adjusting for inflation) to pursue training in them in 2008 than in 2003. ED’s arbitrary gainful employment metric would hamper the ability of colleges to offer occupational training in fields that the market demands by exerting what amounts to government price controls. A better solution to protect the interests of both students and taxpayers would be to ensure that colleges provide prospective students with sufficient information (such as job and income data, and debt and default levels) to make wise education decisions, prior to their enrolling and paying a dime of tuition.

Why The Student Protesters Are Wrong

By Daniel Bennett
Thousands of students on more than a hundred college campuses joined together symbolically yesterday to protest sharp tuition hikes. The students pointed the finger at hard-pressed state and local governments. That was a mistake. State and local subsidies to public colleges and universities increased by 44% in real (inflation-adjusted) dollars during the 25-year period between 1982 and 2007. Had colleges managed to hold their cost increases to the level of inflation over this period, real tuition prices would be slightly less today than they were 25 years ago.
Why weren’t the colleges able to do this? First, colleges are rewarded for fiscal irresponsibility and punished for not keeping up with Joneses. Because we collect very little information from colleges about student learning and educational outcomes, we know nothing about the actual value of the education taking place. So we are left to rely on arbitrary indicators such as price and prestige to decide which institutions are of the highest quality. College administrators understand this and are known to make decisions based on how it will impact their institution’s prestige. The things that boost prestige (fancy dorms, state-of-the-art fitness centers, elaborate student centers, etc.) cost lots of money and do little or nothing to increase the quality of education. The colleges that avoid such elaborate upgrades in lieu of keeping costs down are perceived to be lower -class institutions. Call this the college arms race.
Next, there has been very little, if any, gain in productivity in higher education over the past few decades. Some evidence suggests that there has actually been a drop in productivity, while the information technology age has boosted productivity in nearly every other economic sector. Part of this is explained by the bureaucratic bloat on college campuses. Between 1987 and 2007, the number of senior administrators and professional support staff at public two- and four-year colleges increased by 84 percent, while student enrollment grew by only 37 percent. In this sense, administrative productivity dropped by more than 25 percent during this 20 year period, as the student-to-administrator ratio dropped from 24:1 to 18:1. Meanwhile, faculty teaching loads have diminished by a factor of up to two over the past two decades, while salaries have increased by at least the rate of inflation, not accounting for rising health care costs, retirement contributions and other forms of non-wage compensation. Rather than using technology to cut labor costs and improve employee productivity, colleges have expanded their staffs and seemingly ask less of each employee. Call this diminishing productivity.

Continue reading Why The Student Protesters Are Wrong