To Lighten the Regulatory Load, Focus on For-Profits

Gwenda Kaczor for The Chronicle

October 01, 2017

A version of the following letter was sent in response to the Department of Education’s request for comments on regulations that may be appropriate for repeal, replacement, or modification.

Dear Secretary DeVos:

From the testimony and interviews you have given, I gather that you believe strongly in providing taxpayer funds to colleges owned by for-profit companies. You believe that, relieved of the requirements and restrictions involved with being nonprofit or public, they will yield better outcomes for students, directly and through competition. I assume your belief is genuine and not based on any past, present, or potential future financial motivation.

I assume, further, that you believe that the legal differences in how for-profit vs. nonprofit entities are allowed to operate will yield significant differences in their behavior and decisions. The causes of the divergence in behavior are in the control structure of the enterprise: At for-profit entities, owners and investors make the ultimate decisions and are allowed to keep for themselves any tuition revenue they generate but do not spend. In contrast, at nonprofit colleges it is illegal for anyone to take residuals.

At nonprofits, control rests with a board, appropriately labeled "trustees," with no financial interest in the institution. Board members decide what the college charges, how much financial aid to provide to certain students, whether an expenditure fits the educational purpose of the institution, how much money to hold in reserves. But they cannot take the money for themselves. Much the opposite, they are usually donors of both time and money.

I think we can both agree that investor control has huge potential benefits both for the investors and for consumers. When owners make the decisions, they seek ways to spend less on production while still making the sale. They are personally driven to find ways to expand production to offer their goods and services to more consumers. That is the magic of the invisible hand of the market.

The power of investor-owned businesses to promote innovation and efficiency, and to transform markets, is impressive. But also powerful is private companies’ ability to take advantage of government programs that were not designed with the profit motive in mind. For example, in the case of Pell Grants and student loans, federal higher-education vouchers:

  • Aid can be used to cover tuition as well as for a student’s living expenses, but institutions are free to take the entire amount in tuition, leaving nothing for the costs that a student must face if attending full time. It is no accident that most for-profit colleges charge just above the combined Pell Grant and student-loan total, while offering little or no financial aid for low-income students.
  • Tuition is not required to have any relationship to a market price, allowing a profit-maximizing institution to set it at the entire government-voucher amount, without regard to the value of the program or the actual costs of providing the education. That’s why so many for-profit students end up with huge debts but without the skills to get a job that pays well enough to pay them off.
  • Colleges can grow quickly, without regard to maintaining quality, by recruiting only federally funded consumers — low-income students and veterans — who (wrongly) assume that the federal government is vouching for the value of the education at the price taxpayers are covering. Many for-profit colleges spend more money on marketing than on actual instruction.

Even in the absence of federal aid, for-profit colleges are more hazardous for consumers because of the unusual nature of education as a "product." But at least in a private marketplace, businesses that do not provide adequate value usually fail or remain small. For example, we have recently seen a number of coding boot camps, not financed by federal aid, announce that they will close, while others have grown.

When most, or all, of an institution’s students are getting government vouchers, however, the government is the customer who should be paying attention to whether it is getting value for the money. Yet in the case of federal college aid, the government is assuming, incorrectly, that the students are playing the role of wise shoppers.

When everyone is on federal aid, there is no customer demanding value for the price. You, the leader of this government program, are under the illusion that you are financing a consumer-led market that will evolve toward an equilibrium with better value for the price. But you, not the enrolled low-income and veteran students, are the customer. You must assure value, or the for-profits, controlled as they are by people who can just take the money for themselves, can too easily overcharge and underdeliver, just as they have repeatedly done over the past 60 years when government oversight of for-profit colleges was relaxed.

Why am I raising these issues in response to your request for ideas to reduce the regulatory burden on colleges? Because many of the regulations that nonprofit and public colleges are grappling with were created to address the abuses resulting from for-profit colleges’ participation in the Title IV federal financial-aid programs. Federal micromanaging of accreditation is almost entirely a result of the design of Title IV in the context of for-profit providers. The same goes for the complicated refund requirements, as well as for the state authorization requirements, and even for the gainful-employment and borrower-defense rules.

One way to relieve institutions of the regulatory burden, while improving the treatment of taxpayers and students, would be to exempt institutions that can demonstrate that their assets and revenues are under the control of people without a financial interest in the institution, since those restrictions at public and nonprofit institutions have been shown to largely prevent abuse.

In addition, you could embrace your own theory about the power of the market and require that the college demonstrate its viability without federal aid. In the 1990s, the for-profit University of Phoenix grew quite large, but without major scandal, because employers, who were financing tuition for a large proportion of the students, demanded value. The quality plummeted, however, when the company abandoned that market discipline in favor of grabbing the federal government’s vouchers as the prime target.

If your belief in the power of markets is genuine, then consider inserting a market viability requirement into the design of the programs you manage. It might well make other regulations less necessary.

Robert Shireman is a senior fellow at the Century Foundation and a former U.S. deputy under secretary of education.