On the Puzzle of Out-of-State Tuition

Public institutions typically charge out-of-state students much higher tuition than in-state students. Bryan Caplan and Alex Tabarrok, two leading libertarian economists, have been discussing the puzzle of why that is the case.

They correctly rule out the monopoly or cartel explanation. If public colleges were a monopoly or cartel, they could charge higher prices to some students. But there are lots of competing public colleges, they don’t all charge out-of-state students the same—which undermines the notion of cartel-imposed prices —and under such a model, in-state students would be charged more rather than less since, as Tabarrok notes, “the out-of-state students have 49 states from which to choose while the in-state students may prefer to live closer to home.”

So, what explains higher out-of-state tuition? Caplan argues:

The straightforward explanation for the persistence of the massive price gap is that only in-state students are massively subsidized by their state governments. So instead of picturing out-of-state tuition as a “monopoly price,” we should think of out-of-state tuition as the roughly competitive price.

Whereas Tabarrok argues:

My view is that the in-state fee is close to costs (after the obvious subsidies are taken into account) and the out-state fee is well above cost but that it’s not a “monopoly” price per se because the state-schools are not profit-maximizers.

I think they are both on the wrong track by assuming that either in-state or out-of-state students are paying the competitive price. There are a couple of key pieces of evidence to consider.

First, private—both nonprofit and for-profit—colleges exist and do not charge out-of-state students higher tuition. This tells us that there is something about being public that enables or requires higher out-of-state tuition—since we don’t see it at private institutions—and also that it is not debilitatingly inefficient—since otherwise private institutions would drive publics out of the market.

Second, there is little relationship between subsidies and tuition. In some cases, students at public colleges aren’t subsidized at all. For example, over a decade ago, Charles Schwartz analyzed the University of California (UC) budget and found that (circa 2013) it cost about $7,000 to deliver an undergraduate education, while it charged over $13,000. Or, in his words, “The mandatory fee level for resident undergraduate students was … nearly twice what it cost the University to provide their education.” Also note that the costs of delivering education are actually higher at lower-tier institutions like California State University (CSU) because they can’t outsource as much teaching to low-paid grad students, yet these colleges charge less. In other words, it costs more for CSU to deliver an undergraduate education than for UC, but UC charges more than CSU. This tells us that neither in-state nor out-of-state students necessarily pay the competitive price—with or without subsidies.

Third, markets don’t clear. They use the University of Virginia (UVA) as an example, and UVA only accepts 16 percent of applicants. In a competitive market where markets are clear, changes in price tell you something about changes in demand or supply. But in a market like higher education, which is competitive but where markets don’t clear, changes in price don’t necessarily tell you anything about changes in supply or demand. In other words, the big puzzle isn’t that UVA charges some students more than others, but that it could scale up by a factor of five and yet chooses not to. This tells us that focusing on price is a mistake. Suppose demand from UVA doubles. This would have a huge impact on the competitive price, yet the most likely effect would be that UVA drops its admissions rate to 8% and the price doesn’t change. With apologies to the late Bob Barker and Drew Carey, the price is not right.

So what explains out-of-state tuition? For any higher education puzzle, if Glazer’s law doesn’t work, I resort to Bowen’s Laws:

1. “The dominant goals of institutions are educational excellence, prestige, and influence.”
2. “In quest of excellence, prestige, and influence, there is virtually no limit to the amount of money an institution could spend for seemingly fruitful educational ends.”
3. “Each institution raises all the money it can.”
4. “Each institution spends all it raises.”
5. “The cumulative effect of the preceding four laws is toward ever-increasing expenditure.”

These laws help explain the out-of-state tuition puzzle. The first law explains that public schools are not profit-maximizers not only because they are public but also because their primary goal is the pursuit of prestige. UVA could make more money by expanding to 500 percent of its current size, but that would dilute its prestige because, in higher education, prestige comes from scarcity. So, rather than grow to meet demand, it chooses to turn away over 80 percent of people who want to buy its product.

And if the focus is on prestige, then the price a student pays has only a small influence on their contribution to prestige. Also important for prestige is a student’s academic potential—hence why top schools tend to favor students with high grades and test scores—their athletic or musical potential—the stereotypical dumb jock can be a loss leader for a college when the athletic teams function as effective marketing and recruiting for the school—and even family history—e.g., legacy admits aren’t about the student at all, but about ensuring donations from wealthy parents or grandparents.

Bowen’s third law explains that while colleges won’t raise prices to the market clearing level if that would negatively impact their prestige, they would like to charge as much as possible, everything else equal. Out-of-state students are ripe for harvesting in three respects.

First, unlike in-state students, out-of-state students do not have representation in the state legislature, threatening to cut public funding if tuition gets too high. In fact, colleges can claim that out-of-state students are subsidizing in-state students, even when, like at the University of California, none of the undergraduates are subsidized at all—to be clear, the college is subsidized, but the undergraduate students don’t see a dime of it. This has the added PR benefit of setting the out-of-state price as the baseline price, allowing the college and the state legislature to claim credit for what a good deal in-state students are getting.

Second, out-of-state students have already demonstrated a high interest in the school by being willing to travel much farther, so the college can infer that they are willing to pay more.

Third, out-of-state students come from wealthier families. A student who can fly to college is almost certainly from a wealthier family than one who drives.

Thus, my explanation for why out-of-state students are charged more is a combination of political constraints—the state legislature limiting tuition for in-state students but not for out-of-state students—and revenue maximization—within the context of prestige maximization.

Image by Jared Gould — Adobe — Text to Image