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October 23, 2012

The Beltway For-Profit Witch Trials

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By Daniel L. Bennett

In mid September, the Congressional duo of George Miller and John Tierney joined their Senate colleagues Tom Harkin and Dick Durbin and the Department of Education in what might be described as the ongoing Beltway Witch Trials, where the alleged witches are the colleges that are legally organized on a profit-making basis. Messrs. Miller and Tierney proposed a new line of assault to rein in these alleged evil doers that they have creatively named the College Student Rebate Act of 2012. The objective of the proposed legislation is to exert political control on how private sector colleges allocate their financial resources, as the bill calls for a cap of 20 percent for expenditures on "advertising and promotion activities, excessive administrative expenses including executive compensation, recruiting, lobbying expenses, or payments to shareholders." Expenditures on these activities exceeding the cap would need to be refunded to students and/or the government.

Rep. Miller told the Huffington Post that since "for-profit colleges tend to get a great deal of revenue directly from the federal government...how schools spend this money must be carefully examined."Examination is one thing, but what the bill would really do is enable politicians and unelected bureaucrats to limit the ability of private firms to attract customers and strengthen their brands, compensate their managers for successful performance, protect themselves from additional onerous regulations, and reward owners for their investments. The bill would seriously inhibit the incentive structure necessary to promote private investment, innovation and growth in an industry greatly in need of improved efficiency. 

The bill is simply the latest installment in a series of attempts to rein in the growth and success of the for-profit tertiary education market. Economic data illustrate the success of the private sector colleges. Between 1986 and 2008, the market share of for-profit colleges increased nearly fourfold: from 2.4 to 9.2 percent; and the sector managed to compete for 21 percent of all Pell Grant and subsidized Stafford Loan dollars in 2007-08. Economic theory might suggest that the firms comprising this sector have been successful by putting on their entrepreneurial hats and finding ways to satisfy unmet demand. Other economic data -- namely higher average student debt and default rates among for-profit colleges -- paint a drearier picture of the sector. These data have often been coupled with horror stories of for-profit colleges preying on naïve student victims by luring them in with misleading advertising and promises of a better future as a means to capture their federal aid dollars. While there are no doubt instances of academic malpractice of this sort in all sectors of higher education, I suspect that such instances are the exception rather than the norm. Nonetheless, these testimonies along with the ugly debtdata have spurred a striking amount of criticism about the private sector and initiated the witch hunt.

Readers might recollect that over the past few years our Washington witch hunters have proposed and implemented a variety of approaches to reign in the successful influx of private sector colleges.  This witch hunt coincides roughly with the beginning of the Obama Administration, as the Department of Education initiated the so-called program integrity round of the negotiated rulemaking process in 2009. Out of this process eventually came the highly controversial gainful employment rules, part of which were recently overturned by a Federal court, as well as other less publicized regulations including a ban on the use of incentive compensation and stricter rules concerning the link between student loan default rates and eligibility for federal student aid programs. Additional legislative and regulatory changes, including a decrease in the share of a school's revenue that is legally permitted to come from federal financial aid as well as stricter rules over the use of veteran's education benefits at private sector schools, have been promoted by Messrs. Harkin and Durbin, but have failed to pass muster.

Recent reports indicate that enrollments have declined for many schools in the sector. In addition, several for-profit companies have announced substantial job cuts and campus closures. A hostile regulatory environment coupled with an onslaught of negative press has played an influential role in slowing the growth of the sector. For our witch hunters, this news is likely encouraging that their efforts are exerting the desired effect.

The private, profit-seeking colleges were previously at a competitive disadvantage compared to public sector schools that receive myriad direct subsidies and tax exemptions. That for-profit schools have been able to compete is a sign of entrepreneurship and optimism that higher education can be delivered much more efficiently when organized using market-oriented processes. Recent regulatory changes have further tilted the competitive playing field in favor of the non-profit schools. The latest effort to further constrain the competitiveness of the for-profit schools, the Miller-Tierney bill, seeks to limit the functions that enable firms to promote innovation and growth, as well as those that enable defense from an overzealous state.

These policies are anti-competitive and anti-entrepreneurial -- two facets that deter a vibrant market economy. These acts of political gamesmanship appear to be characteristic of the disturbing trend towards competition through the political process rather than the market. The successful erection of entry barriers and other competitive advantages gained through the political process increases the attractiveness of crony capitalism and results in a redirection of resources from productive to unproductive rent-seeking activities. This entails a loss of efficiency as well as a reduction of societal well-being. While a few bad for-profit actors will likely experience an accelerated exit from the market as a result of the ongoing witch hunt, the benefits of doing so are likely far surpassed by the costs of reducing the competitiveness of private enterprise and a rise in cronyism.

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Daniel L. Bennett is a Ph.D. student in economics at Florida State University, a Mercatus Center Adam Smith Fellow, and a Research Fellow at The Center for College Affordability and Productivity.



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