Financial Aid Subsidizes Consumption
In my previous post about education, I looked at the discinentives upper middle class students face for attending top schools. Today, I want to look at another negative effect of such aid - over consumption. Consider the bright 22 year old who has recently graduated college. Let’s say this student plans to attend law school in a few years, but decides to work first. We would expect that he either saves money, or holds onto the money he already saved. By doing so he benefits the country (by increasing national investment -econ 101), picks up some good habits for himself, and reduces deadweight loss*. However, being bright and savvy, this student realizes that most schools look back at your savings before deciding how much financial aid you receive. No savings? Law school is free**. 300,000 dollars in the bank? You get nothing. Since attending a top law school costs about 150,000 dollars, a student who had money but spends it all saves 150,000 dollars. This significantly distorts the behavior of those who have enough money to ‘afford’ school, but not enough where saving 150,000 will not represent a significant subsidy. While all tax subsidies distort peoples preferences, financial aid seems particularly pernicious because its effect is so massive, and its progressiveness is so high.
What can be done?
- Schools can place a greater emphases on past income rather than past savings. This would act as a tax on income rather than savings, which has been shown to have fairly small differences on a person’s behavior***.
- We could forgo financial aid in the first place. Since about 50 percent of students at top schools (at least at colleges) receive financial aid, making everyone pay full bill would halve the price of tuition. The counter argument people usually make is that university generally costs more than what even full paying students pay. This may be true, but it does not change anything. If the school only needs X dollars total from the students, than if you double the number of paying students you would halve X. Certainly wealthier students would benefit, but so might poorer students:
- A) It would reduce the feeling of entitlement that people feel. When people feel entitled they are less apt too work hard and more apt demand others give them their ‘due’. Belief that you are entitled to what someone else has is just a disguised belief in socialism. This is bad for everyone.
- B) It would give an incentive for graduates to make use of there college education by accepting better paying jobs and forcing them to work harder. Utility may decrease for those compelled to work harder, but this would probably be good for the country in general. By reducing financial aid we are removing a particularly distortionary subsidy. The aggregate wealth of America would increase, and this wealth could be better distributed through better taxes.
* Almost all taxes (ignoring those intended to prevent negative externalities) that modify a persons behaviour create aggregate economic losses. If we can prevent behavior modification, we are more likely to have struck upon a good tax.
** Many Law Students from upper middle class families have money in the bank from parents and family, but earn relatively little themselves. Income is a factor, but for people in there 20s, it is already low. College is trickier because financial aid is based on parental income and savings.
*** Increasing taxes reduces the value of each hour worked, but it also forces you to work harder to maintain your financial situation. These effects tend to cancel each other out.
June 17th, 2007 at 4:51 pm
Economics and Social Policy XXXVIII…
Welcome to the June 17, 2007 edition of Economics and Social Policy….