No. 759: Is It Time to Change How We Pay for College?

Beginning as early as elementary school, students have it drilled into them that they must go to college to get a good-paying job. Indeed, as our economy has changed over the past half-century, there is today a close correlation between educational attainment and wage rates. So for individuals who have the interest and aptitude, a college degree is the ticket to prosperity. 

Recognizing this, college students receive a tremendous amount of help. Only 18 percent of the revenues to public universities and colleges come from student tuition and fees. The biggest single source of income for public higher-education institutions is state appropriations. Translated, this means state taxpayers are picking up the biggest part of the tab for public colleges. 

There is an economic rationale for the public subsidization of a college education. Economists say a college education creates a “positive externality”, meaning it generates positive impacts on the economy beyond the direct financial and intellectual benefits to graduates. College-educated workers are better able to use modern technologies and processes, thereby creating improvements in labor productivity that lower business costs and reduce product prices to consumers.   

Yet despite the big break college students receive in their costs, student tuition and fees have been rising in real (inflation-adjusted) terms. The 18 percent of college revenues paid by students is up from 13 percent 20 years ago. Annual tuition and fees at public four-year colleges jumped 143 percent, in inflation-adjusted terms, between 1976 and 2003, more than six times faster than the increase in median household income.  

So despite the substantial assistance college students receive from taxpayers and other sources, college costs for students and their families have become less-affordable.  How does this make sense when a college education has become more important? Won’t these increased costs cause some students to not attend college? 
Not necessarily, if the benefits of a college degree are compared to its costs. Yes, the inflation-adjusted cost of four years of tuition and fees at public colleges rose from $7,359 to $18,776 between 1977 and 2003. But the extra lifetime income earned by a college graduate compared to a high school graduate increased by more than $130,000 over the same time period. 

So what’s the problem? For many students and their families, the problem is they can’t come up with the money for tuition, even though they know these costs will be repaid many times over with the extra income earned by having the college degree. 

Of course, there’s the option of private and public loans and financial aid. These are important sources of support for college, and it certainly can make sense to borrow today in order to earn much more in the future.

However, an idea discussed in Europe may increase access to college, while at the same time establish a permanent revenue source for college funding.  

The idea accepts the notion that state taxpayers benefit from a college-educated workforce because of positive externalities generated by college-educated workers. So, as they do now, state taxpayers would continue to share in the costs of higher education.
 
But the plan is secondly based on the obvious fact that individual students directly benefit from a college education by earning substantially more income over their lifetime. 

A way to combine these two points is this. Students would attend state-supported public colleges and universities tuition free. Students would, however, continue to pay room and board, for the simple reason that these costs aren’t directly related to college. If the individual weren’t in college, he or she would still have to live somewhere and eat, so room and board costs would continue. 

Also, there would need to be some limits on the amount of time students were in college. Perhaps if they weren’t finished after five years, their tuition-free ride would end. 

Here’s the unique part of the plan. Once students graduated from college and were working, they would be required to repay a percentage of the total costs of their college education — maybe 50 percent of the costs — from the increased earnings they derive by having a college degree. If desired, policymakers could vary the percentage repaid with the earnings level of the student, and the repayment rate could be substantially higher for students who leave the state upon graduation.

With the increasing importance, and value, of a college degree, this is an idea whose time may be now.