Tuition Cuts and Tuition "Cuts"

In a recent report on the state of legal education, Moody's, the credit rating service, noted in passing that tuition cuts are not necessarily an effective tactic for improving enrollment. The rationale is important for people to understand.

Tuition cuts might not be all that they appear to be. The reason is virtually all institutions of higher education already discount tuition to a great extent. Almost all of them also are tuition dependent: Their operating budget comes from what students pay them.

That is the case for the highly-regarded and the not so reputable. Public institutions and those that value public service typically return a significant amount of their tuition revenue to their students in the form of need-based financial aid. Other schools that wish to recruit highly-credentialed students award scholarships on the basis of those metrics. Some of the moneys for these purposes may come from endowments, but much of it comes from what students themselves are putting into the coffers.

Whether it is meant to help many students by offering the opportunity for higher education or buy a few of them by rewarding earlier academic records, the budgetary consequence is the same. As with most other ventures, there is a difference between gross and net.

So a tuition cut may well leave many, perhaps most, individuals worse off as compared to the baseline. Here are the consequences of a cut to tuition.

Assume before it publicizes a cut, a school has a program oriented toward need-based grants. It may be giving as many as three-quarters of its students such packages. Only a quarter of them are paying the full sticker price. Three-quarters pay less; the one-quarter make that possible.

Now after a cut, that school has two choices. (We can put to the side the equivalent of money falling from the sky: alternate revenue sources. They exist, but they usually are an order of magnitude less than what would be needed to offset significant tuition decreases.)

The first option is a real cut. The school could reduce expenditures in a manner commensurate to its loss of total tuition coming in. To be pointed about what that means: Since human resources are the bulk of the budget, such a real cut means faculty, staff, or both, would have to be paid less or be laid off. Savings from the non-personnel share of the budget are not likely to be sufficient to make ends meet.

The second option is the illusion of a "cut." The school could reduce what insiders call the "discount rate" to exactly the amount that makes up for the tuition drop. Again to be pointed about what that means: Given that most students previously received generous grants, most of them end up actually paying more. The students who were not receiving grants prior are the only ones who in fact benefit.

To illustrate it with numbers, consider the simplest possible example. Suppose Acme Law School had two students (in this hypothetical, each of them stands in for hundreds who are treated identically); and a "rack rate" of $50,000 per year. Alpha, who is impoverished, receives a $10,000 grant; Bravo, who is well-to-do, receives no grant.

The real cost of attendance for a year (not including living expenses) is as follows. Alpha expends $40,000 ($50,000 tuition less a grant); Bravo, $50,000 (the stated tuition with no break).

Imagine then Acme Law School announces a tuition cut of 10 percent or $5,000. Its new, much-praised "flat rate" is $45,000.

But the leaders of Acme Law School do not wish to affect its programs. That frames their intentions in the most positive terms. They need to maintain the same overall revenue the school was receiving from Alpha and Bravo notwithstanding the cut, which is $90,000 (the $40,000 from the former plus the $50,000 from the latter).

Accordingly, to achieve their goals, they direct that the financial aid program be zeroed out. Alpha and Bravo each pay $45,000. The school receives $90,000 as it always has. Transaction costs are lowered as a side benefit.

Look at what has happened to Alpha and Bravo. They have switched places. Alpha pays more than before, $45,000 instead of $40,000; Bravo pays less, $45,000 instead of $50,000. Alpha has a subsidy taken away; Bravo benefits.

Note too this is not ideological. If you object to Alpha receiving need-based financial aid to begin with, change the example to a credentials-based scholarship. So in this variation, Alpha, who has scored at the top of the range on standardized tests and been valedictorian from her undergraduate alma mater, would have been offered a $10,000 scholarship. That is eliminated with the tuition cut.

Thus, at a school that has announced a tuition cut, there must be, sooner or later, an announcement of the real cut that matches it. Absent that, the inference that can be made is that only the illusion of a cut has been presented. It is marketing, puffery, call it what you will.

The same can be said of flat-rate tuition programs more generally. It's no different than flat-rate taxation proposals. The resulting flat-rate may or may not be a better deal than varying rates, depending on a student's individual situation.

All of the above is exacerbated by the lower levels of enrollment at law schools. A school trying to balance its budget, as all of them need to do, can compensate for lower enrollment with higher tuition, or vice versa. But simultaneous downward trends on enrollment and tuition cannot be sustained without even greater real cuts to spending, financial aid, or both.

Whatever people think about the cost of higher education, it is important to understand the choices that decision makers face. Much of what looks like reform may be symbolic.