Higher Education

State Budget Cuts Don’t Explain Tuition Increases

December 2, 2016

Preston Cooper

By Preston Cooper

History is replete with examples of obvious yet incorrect answers. The sun revolves around the earth. Labor inputs determine a good’s value. Now, another example has emerged. In the aftermath of the Great Recession, an obvious—yet ultimately incorrect—explanation for the rise in college tuition has gained currency.

The blame is fixed on state legislators, who tightened state budgets for higher education in the face of falling tax revenues after the economic collapse. The result, in this telling, is that universities were forced to make up for the shortfall by increasing tuition charges. The story makes sense on its surface, but the data do not support it.

To understand why, it is important to consider that higher education is a unique sector of the economy which is not bound by the usual rule of minimizing costs. As colleges cannot easily measure unit costs—you cannot measure a “unit” of education the way you can measure a ton of steel or a bushel of wheat—they must instead benchmark their costs to available revenues. Economist Howard Bowen proposed this idea in 1980 as the “revenue theory of costs.”

When revenue streams widen—say, through an expansion of the federal student loan program—colleges will find new ways to spend the money. Shiny new academic buildings, world-class athletic teams, or expanded university administrations are all channels for the newly available funds to be spent. As OCPA research fellows J. Scott Moody and Wendy Warcholik have pointed out, the administrative bloat problem is particularly acute in Oklahoma. Moody and Warcholik show that Oklahoma’s colleges employ 2.4 non-instructional workers for every 100 private-sector workers—a ratio 61 percent higher than the national average.

What does all this have to do with state budgets? Generally, universities attempt to maximize all available streams of revenue. It matters little whether state legislators are generous or tightfisted; colleges will increase tuition at similar rates in either scenario. Budget cuts represent reductions in available revenue streams, so institutions will find ways to cut expenses in order to adjust to the new normal.

This last point is key. While many people assume that colleges must match every dollar lost to budget cuts with another dollar in tuition increases, in reality there is no strong association. Economic analyses generally find only a small effect of budget cuts on tuition increases, on the order of pennies on the dollar. Others find an effect in the short term, but not in the long term.

This explains why private universities in the United States have also seen substantial tuition inflation since the Great Recession, even though they do not bear the brunt of state budget cuts. Both public and private universities are bound by the revenue-maximization principle.

In Oklahoma, state and local appropriations per full-time equivalent (FTE) student at the average four-year public college fell by $1,290 in real terms from 2006 to 2013. Contrary to stereotypes about the Sooner State’s ruby-red politics, these cuts were much less dramatic than the $1,979 average cut the rest of the nation faced. But these reductions in appropriations do not neatly match up with increases in tuition—some colleges with large appropriations cuts had small tuition increases, and some schools with appropriations increases still saw tuition grow at a fast pace.

Among four-year public colleges nationally, changes in state and local appropriations from 2006 to 2013 explain just 0.5 percent of the variation in changes in tuition revenues over the same period. Among the 14 four-year public colleges for which data are available in Oklahoma, changes in appropriations explain around 0.9 percent of changes in tuition revenues.

Some caveats. Eliminating the obvious outlier on the graph (the University of Oklahoma Health Sciences Center) raises explanatory power to 18 percent—somewhat larger, but still well short of being the dominant factor. Eliminating outliers among the set of all public schools nationwide yields explanatory power of just 5.5 percent.

This analysis is also just a correlation, and so does not definitively rule out that state budget cuts have an effect on tuition charges. Like all economic theories, the revenue theory of costs is imperfect, and thus cannot explain 100 percent of variation in tuition. In reality, changes in state appropriations likely do have some effect on tuition charges.

But what this analysis can tell us is that budget cuts are not the primary cause of tuition increases. Not even close. They are probably a factor, but far less important than others—among which the most important is doubtlessly the availability of taxpayer subsidies through the federal student loan and Pell Grant programs.

What are the implications for policymakers? Increasing state appropriations to Oklahoma’s colleges on the expectation that tuition will fall concomitantly is a very dubious bet. It may take a five- or 10-dollar increase in appropriations to generate a one-dollar reduction in tuition, if that. Certainly there are better uses for the money in an era of tight budgets.

Tuition inflation is a serious problem, which saddles younger generations with unnecessary debt and scares many prospective students away from even applying. Policymakers should engage with inflation’s causes, but also recognize that cuts in appropriations are pretty far down on the list.

Preston Cooper is a fellow at the Manhattan Institute, where he focuses on the economics of higher education. He writes a regular column for Forbes.com, and his work has also appeared in U.S. News & World Report, the Washington Examiner, Fortune, and other publications.