Specifically, financial aid programs fuel an arms race in spending among schools. Programs are structured in such a way that governments are essentially subsidizing the inflation of college costs. Schools generally cannot compete with each other by demonstrating that they provide a better education than others, because the outputs of school (learning and its consequences in a value added sense) are not measured. Since there are not generally accepted measures of outputs, and it is reasonable to think that high quality inputs will lead to high quality outputs, schools compete on inputs instead.
If the goal is to increase equality of opportunity, then financial aid in the form of lump sum subsidies and widespread loans will only be partially effective, and may even be counterproductive. The burden for low-income students may be lowered, but the burden on many will not be affected. … To avoid contributing to the arms race, grants and loans need to be restricted to low-income students exclusively. Any aid made available to students who can already pay for the cost of attendance will simply encourage schools to try and ‘capture’ that aid, which will then be used to fuel the arms race.
For more recommendations on how Pennsylvania should reform our system of funding higher education, check out our policy brief.