What Factors Are Driving Rising College Costs?

September 23, 2021

What Factors Are Driving Rising College Costs?

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Over the last 20 years, the cost of college tuition at nonprofit institutions rose more than any other U.S. consumer good or service besides hospital care. Now, a college education is the second-largest expense a person will likely ever make, right after buying a house. The cost of a college degree in the U.S. supersedes any large country in the developed world.

In 1978-79, it cost $17,680 per year to attend the average private college and $8,250 per year to attend the average public college, after factoring in inflation. Forty years later, those respective costs increased to $48,510 and $21,370. This constitutes a 174% increase in tuition at private colleges and a 159% increase at public colleges. And these rates show no sign of slowing down.

So, why are education costs rising so rapidly? And where are all of our tuition dollars going? It turns out a few different factors contribute to rising college costs.

America's Student Loan History

Rising Demand and Limited Supply

Between 1990 and 2020, the total number of college students in the U.S. increased from 13.8 million to nearly 20 million. The flock to college campuses comes from the widespread perception of the college degree as the "golden ticket" to the middle class. Employers also contributed to this trend because of their increasing preference for degree-holding candidates.

The pressure to pursue higher education and the competitive admissions process means students will pay higher amounts in tuition, prompting colleges to raise their prices. Unlike other expensive goods and services that drive a certain demographic out of the market — for example, a luxury car or a lavish vacation — the pressure to get a degree means families that cannot afford the cost of higher education will still find a way to pay.

Usually, the cost of products and services decreases over time as new providers enter the market. Examples include electronics, toys, apparel, and airline tickets. One of the main reasons this has not happened in higher education is large barriers for new schools. One barrier includes securing accreditation, which is a time-consuming, rigorous process.

This creates an oligopoly, or a market with limited competition, in higher education. This lack of competition discourages the leveling effect of supply and demand that should theoretically keep prices from skyrocketing. And the decreasing number of colleges due to closures and mergers will not help to alleviate this problem.

Financial Aid

When Congress passed the Middle Income Student Assistance Act in 1978, all undergraduates became eligible for Pell Grants, regardless of financial standing. Naturally, a huge influx of students began to apply for financial aid.

"Knowing that students will get this financial aid money, the university raises fees and takes advantage to capture that themselves," Richard Vedder, a professor of economics emeritus at Ohio University, told Business Insider.

Ironically, financial aid, which is supposed to make higher education more accessible, could actually contribute to rising college costs.

President Reagan's Education Secretary, William Bennett, began to speak about the phenomenon in the 1980s. It became known as "the Bennett hypothesis," after he published a New York Times op-ed called "Our Greedy Colleges" in 1987. President Obama also acknowledged the issue during his presidency, but the problem persists.

According to some estimations, for every new dollar of federal student aid, tuition increases by up to 65 cents.

Rise in Administrative Costs

Experts also attribute rising college costs to greater administrative spending at colleges. This phenomenon is known as the "administrative bloat." While professor salaries remained fairly flat for decades, spending on services like admissions and registration increased 31% between 2003 and 2018.

According to FREOPP, professors now account for less than half of employees at most four-year schools. Colleges blame the Department of Education and the accrediting organizations, which increased rules and regulations over time. This requires additional staff to provide detailed documentation proving educational quality and compliance.

Cuts in State Funding

Financing from state and federal governments contributes substantially to public colleges' funding. This funding constitutes more than a thirdof their revenues. But the amount that schools receive has dipped significantly since the Great Recession.

After adjusting for inflation, the total state funding that public two- and four-year colleges received in the 2017-18 school year was more than $6.6 billion below contributions in 2008.

Colleges reacted by raising tuition, and in some cases, cut faculty and certain course offerings. State funding has begun to climb slowly since 2012 but still has not returned to pre-recession levels.

A Closer Look at Increases in Tuition

For the 2018-19 academic year in the U.S., annual prices for an undergraduate education averaged about $18,380 at public institutions and $47,420 at private nonprofit institutions — a 28% and 19% increase from 10 years prior, respectively. Most of these increases come from tuition and housing.

Looking at a smaller window of time, between the 2017-18 and the 2018-19 school years, public four-year schools in the U.S. increased tuition by an average of 2.97%. Over the same period, private four-year schools increased tuition by an average of 3.85%. These average yearly rates of increase have remained fairly constant since around 2000.

These margins may sound small. But, for example, if private four-year schools charge $30,720 on average for tuition annually and that cost increases by 3.85%, students will pay about $1,100 more over a year.

Looking at college costs by state, the most rapid increases over the same period within public four-year institutions occurred in Alaska and Iowa, at 16.27% and 13.67%, respectively. New Mexico and Iowa grew the fastest within private four-year institutions, at 26.28% and 20.83%. (These rapid increases could be because these states have fewer schools. So, if one college increased its tuition significantly during that time, it could skew the state's average.)

In less than 10 years, some schools' yearly tuition will surpass $100,000 if these increases in average rates continue.

The Pandemic's Effect on Rising College Costs

According to sources that spoke with Forbes, there is a link between college costs and the coronavirus. Universities lost hundreds of millions of dollars in revenue due to COVID-19. Major revenue streams from college sports, campus dining, and dorms evaporated overnight.

The University of Wisconsin at Madison projects a $100 million loss. University of Arizona estimates a $250 million loss. Syracuse University has already lost $35 million since the onset of the pandemic. And the University of Michigan estimates losses from $400 million to a whopping $1 billion.

With colleges and universities experiencing such significant losses in revenue, experts say that tuition costs could climb at an even faster rate.

The Effect of Rising Tuition on Students and Graduates

Student debt impacts young people more than in previous generations. Student loan debt increased 76% since the class of 2000, exceeding the inflation rate by 41%. As of 2021, student loan debt stands at about $1.7 trillion.

Graduate student debt contributes a disproportionate amount. While only one-fifth of student borrowers are grad students, they account for 40% of total student debt in the U.S. Today, about 13% of people have a master's degree, about the same fraction that held a bachelor's degree in 1960. Experts attribute this trend to the increased competition among job seekers.

This financial burden results in many worrisome consequences, not just for borrowers but for the U.S. economy.

Unsurprisingly, financially strapped college graduates spend less money. According to the National Association of Realtors, more than half of home buyers under the age of 36 said that student debt delayed them from buying a house. Today's graduates are also less likely to start businesses because their debt causes them to avoid financial risks.

These behaviors affect the growth of our economy. The Federal Reserve estimates that student debt reduces the GDP by .05% per year.

How Colleges are Being Affected by Rising Costs

Rapid tuition increases are finally catching up to American colleges. Even before the pandemic, higher education began to see a national decline in enrollment. Between the 2014-15 and the 2018-19 academic years, annual undergraduate enrollment dropped by 1.25 million students, a 5% decline.

To attract students, colleges have been adding more facilities. This includes new academic buildings, nicer dorms, and more extravagant recreation centers. These updates may make campuses more appealing to potential students, but they add further financial strain.

Now, about 25% of private colleges run deficits. Some private schools even closed their doors for good. Others avoided financial ruin by merging with other schools. Public schools face similar problems. The number of public four-year universities declined by 2.3% from 2019-20 to 2020-21. Experts expect to see this trend continue.

While enrollment in traditional colleges has declined consistently over the last decade, interest in online learning and certificate programs has continued to rise. Some students prefer at-home learning. But many find online programs' lower tuition rates appealing. And since the pandemic, the stigma around online learning has decreased.

While online models cannot replace certain benefits of in-person learning, parents and students will begin to wonder if those benefits justify the discrepancy in cost. And as education costs rise, outpacing inflation and wages, the cost-benefit analysis of traditional on-campus learning may reach a tipping point.

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