Outcomes-based funding can help drive innovation

By: and

Aug 23, 2018

This piece is from a larger discussion on higher education regulation that originally appeared on EducationNext. Check out the full piece, and a corresponding perspective by Kevin Carey, Director of the Education Policy Program at New America.

Every year the federal government spends more than $100 billion on higher education, mainly in the form of grants and subsidized loans to students. The historical purpose of this spending has been to broaden access to higher education. Without federal subsidy, students from low-income backgrounds would struggle to afford higher education. They would lose out on the personal and economic benefits that accrue from higher levels of educational attainment, and society would miss out on their potential contributions.

Although federal spending on higher education has expanded access, it has also had an unintended effect. Federal funds are available on a pay-for-enrollment basis: as long as students are enrolled in an eligible degree or certificate program, they can receive a Pell grant or apply for a loan. This practice allows students to enroll in programs with low course-completion and graduation rates. Funding is not tied directly to a program’s track record of placing students into good jobs, and inevitably, some students end up with debt that they struggle to repay.

With pay-for-enrollment, the government ends up investing taxpayer dollars in programs with a low return, whether measured by loans repaid or by social benefit. On top of this, recent evidence suggests that federal spending has partially fueled the annual tuition increases that in recent decades have become endemic at colleges and universities. For instance, David Lucca of the Federal Reserve Bank and his colleagues examined the connection between the expansion of student-loan credit and the rise in college tuition from 2000 to 2012. They found a “pass-through effect on tuition of [increases] in subsidized maximums of about 60 cents on the dollar for subsidized federal loans” and smaller effects for unsubsidized loans.

Absent fiscal incentives, lawmakers and regulators have historically relied on complex, clunky, and mostly input-laden definitions and rules to try to lure good behavior out of higher-education providers. The current Higher Education Act (HEA), for example, spells out 10 standards for college accreditors to monitor, only one of which pertains to outcomes. This strategy has failed on two counts. First, although aggressive regulation in the Obama years may have forced a handful of for-profit schools out of business, the federal government’s historical policy-and-regulatory approach has not raised the quality of the higher education sector as a whole. Instead, the incentives have, by and large, encouraged schools to imitate each other rather than striving to improve continually and according to their own goals. Second, an input-driven approach in which the resources and processes of higher-education providers are tightly controlled is, by definition, stifling to innovation, because it limits how programs may deliver their services. The result has been too much regulation and, at the same time, far too little accountability.

Based on the last several decades of federal higher education and K–12 policy, we know that input-based regulation is both stifling to innovation and ineffective at bolstering student outcomes. Eliminating rules for the sake of driving innovation without developing a new outcomes-based regulatory approach, however, risks further lowering the individual and societal returns on higher education. The reason is that federal aid has created a third-party-payer market in which college costs are obscured for students paying through financial aid. Conservatives who oppose any regulation of higher education providers by Uncle Sam and who believe in an unconstrained free market are ignoring the lessons from the rise of poor-quality for-profit providers over the previous decade and the fact that no free market operates with money lenders that do not assess the creditworthiness of the people and projects to which they are lending.

So long as federal dollars follow students to institutions in a third-party-payer market, it stands to reason that the federal government should have a role in evaluating which institutions are eligible for how much aid. Funding mechanisms should ultimately reward programs that achieve a strong return on investment and defund programs that don’t work, an approach that could spur innovation in ways that benefit both students and society.

With the pending reauthorization of the HEA, policymakers have an opportunity to craft a framework that unleashes innovators and stimulates them to focus on creating value for students and society. The key, though, isn’t to debate whether there is too little or too much regulation but to concentrate on paying innovators for outcomes instead of constraining them by regulating inputs.

To read the full discussion on the role of regulation in higher education, check out EducationNext’s forum on Rethinking the Rules of Higher-Ed Spending.

Alana leads the Institute’s higher education research and works to find solutions for a more affordable system that better serves both students and employers. In this role, Alana analyzes disruptive forces changing the higher education landscape.

Michael is a co-founder and distinguished fellow at the Clayton Christensen Institute. He currently works as a principal consultant for Entangled Solutions.