Effects of Removing State Postsecondary Grant Aid Eligibility

In response to tightened budgets and concerns about higher education costs, the federal government and several states have implemented or considered rules to limit the use of publicly funded grant aid at some schools, particularly at for-profit colleges. While there is some evidence supporting the Bennett hypothesis (that colleges respond to increases in financial aid by increasing tuition or decreasing institutional aid), the effect of reducing or removing aid is unclear since prices are thought to be sticky in this market. In this paper, we characterize how schools may respond heterogeneously to a state subsidy reduction based on their distance to federal aid eligibility thresholds. We then use an event study framework to estimate how tuition, net prices, enrollments, and loan use changed at for-profit colleges that became ineligible for California’s state grant aid program. Typical schools reduce tuition relative to unaffected schools, but schools close to the federal eligibility threshold actually increase tuition, as predicted. These results support the notion that the Bennett hypothesis holds in reverse in the for-profit sector. ∗Job market paper. The research reported here was supported by the Institute of Education Sciences, U.S. Department of Education, through Grant #R305B090009 to the University of Wisconsin-Madison. The opinions expressed are those of the authors and do not represent views of the institute or the U.S. Department of Education. †Click here for latest draft. As rising prices of higher education have led to increased scrutiny of the market in recent years, researchers and policymakers have reevaluated how best to subsidize postsecondary educational attainment. In 2013, the U.S. federal government disbursed $137.6 billion to 14 million students through the federal government’s main student financial aid program, Title IV (U.S. Department of Education, 2013).1 State governments, meanwhile, disbursed more than $11 billion of aid to students in 2012 (National Association of State Student Grant and Aid Programs, 2013). Rationing school funding based on outcomes has become increasingly popular and some policies have specifically targeted schools that, rightly or wrongly, are perceived to be low quality institutions. This has especially affected for-profit colleges, which typically have poor performance measures, high tuition, and receive a disproportionate share of federal student aid. Policymakers may hope to shift students to cheaper and/or better-performing colleges and prevent schools from capturing government dollars by charging higher prices, but the extent to which this happens depends on characteristics of the affected markets.2 Moreover, interacting state and federal policies that regulate the higher education market may have unintended consequences that cause some prices to increase with a reduction in grant aid eligibility. In this paper, we analyze how schools respond to losing state grant aid by examining a natural quasi-experiment: changes in school-level eligibility requirements for California’s state grant program, Cal Grant. Using an event study framework we find evidence that schools decrease tuition upon the loss of state grant eligibility by almost the full amount of effective lost aid. Despite this reduction in sticker price (and net price for many students), enrollments decline in affected schools, suggesting that most grant-eligible students substitute away from ineligible schools. In contrast to the main result, schools that are close to losing federal aid maintain or increase tuition to maintain eligibility which may run counter to policymakers’ intentions to decrease prices by reducing aid generosity. Concern over institutional capture of financial aid moved into the policy debate following former Secretary of Education William Bennett’s 1987 op-ed in which he hypothesized that growing government subsidies for education (in the form of grants and loans) have allowed This program includes entitlement programs such as the Pell grant, the Federal Supplemental Educational Opportunity Grant, work study, and Stafford, Perkins, and PLUS loans. Policymakers may also hope that by decreasing subsidies to colleges with poor performance measures these colleges either improve or leave the market.