Thursday, November 05, 2009

Harvard Financial Aid

This post will talk about Harvard's financial aid program, and why it's a perfectly good thing to give money to Harvard, despite what you might read in the New York Times.

I am motivated to write about this also because some weeks ago, I got into a blog-argument with some Chronicle of Higher Education writer who gave an incoherent argument that Harvard should have been spending its endowment increasing its undergraduate class size. (See the bottom of this post for the starting point if you want.) One point I argued was that Harvard had in fact been spending its endowment to make college more affordable through its financial aid program, and that that was probably doing more to open Harvard up to a wider talent pool than simply admitting more students would do.

Certainly one can argue whether teaching more students or making Harvard financially available to more students is a more important goal. But one thing that became clear is that that author, the author of the New York Times opinion piece, and I presume many other people, just don't understand the financial aid picture at Harvard. So I'll say something about it, that's actually based on facts and numbers.

Let me start with a back of the envelope calculation. (I recently got access to some official numbers, but they may be confidential, and the back of the envelope calculation is easy and accurate enough.) About 2/3 of Harvard undergraduates get financial aid from Harvard, and on average it covers about 2/3 of their tuition. That's approximately 4000 students, getting an average of about $35,000 per year in aid from Harvard, for about $140 million per year. Let's call it $125 million in case my numbers are off and to make the math easier.

Long-term endowment spending rates are about 5%. (This seems to be a standard rule across most major universities, but I haven't seen an economic analysis to explain this number. Please give pointers in the comments.) So Harvard's undergrad financial aid corresponds to roughly $2.5 billion of endowment money.

This is a much bigger proportion of the endowment than people realize. Usually people bandy about a figure of $27 billion or so post-crash for Harvard's endowment, but the endowment for the Faculty of Arts and Sciences -- that is, for the undergrads, as opposed to the law/business/medical/graduate/etc. schools -- is only about $11 billion. So Harvard is now using, by my estimates, well over 20% of its annual endowment spending (for FAS) for financial aid. I've argued in the past that Harvard should make itself tuition-free for undergraduates -- but even I'm impressed by and happy with these numbers.

Think of it this way: the projected deficit for FAS over the next few years, roughly speaking, could disappear entirely without any budget cuts if we just turned off financial aid. Of course that's a terrible idea, and financial aid is one area where Harvard, so far, is making sure not to cut. But that gives an idea of the scope.

So when I hear people say that Harvard isn't doing enough to open its educational doors, or suggesting that giving to Harvard is not morally sound, I admit I feel obliged to politely correct them. (Or, sometimes, less politely correct them.) If you believe that affordable education is important, there are of course many institutions deserving of support. Harvard remains on that list.


Anonymous Professor said...

The 5% spending rate is lower than the typical return of a long-term portfolio (7%-8%). So, being on the conservative side, the 5% spending rate should last forever, allowing the endowment to increase as well.

This, of course, assumes a distribution of returns across years that is more near the normal distribution than the real heavy-tail distribution of returns :-)

Russ Ross said...

As I understand it, charitable foundations are required to spend 5% of their endowments every year (possibly averaged over three years or so?). Universities are not, but congress sometimes makes threatening noises about extending the requirement to them when they don't like something.

By maintaining that spending level voluntarily, universities (especially those like Harvard with a high profile) appease the lawmakers and reduce the risk that such a level will be forced on them.

So, in short, the 5% rate has less to do with economics than politics.

p.s. I received generous financial aid from Harvard, and would not have been able to attend without it. Even 14 years ago they were the most generous school I encountered, and they have loosened the purse strings considerably since then.

p.p.s. I was a student in CS124 your first semester teaching it, and was in the inaugural CS222 class as well.

Anonymous said...

5% spending has been standard for many years. It always depends on what the time frame is. Of course 20 years ago many savings accounts also had 5% interest rates built explicitly into their terms of service.

With the recent drops in endowments some universities have cut back even from the 5% to 2.5% pay-outs.

Anonymous said...

...on average it covers about 2/3 of their tuition. That' average of about $35,000 per year in aid

Are you saying that Harvard's tuition is $35,000 * 3/2 = $52,500 per year?! And that does not include housing, books, etc.?!

Anonymous said...

Here's a great idea to increase the endowment spending - raise tution to $60K/year. I bet 1/10 of Harvard's current students can pay full tuition. Keep the total income Harvard gets from tuition constant by raising aid the the rest of the students, and you're done.

So student aid seems somewhat artificial - any answer for this?

Michael Mitzenmacher said...

Anon #4 : Tuition and fees was, I believe, over $36,000 in 2008=2009. The $50,000+ figure I used, I believe, includes room/board and additional expenses (books, travel to/from Harvard, etc.), and from what I understand these are included when determining the financial aid package.

Michael Mitzenmacher said...

Russ -- Always nice to hear from old students! I hope you look back at your time at Harvard fondly. And I thank you for not commenting on what I was like as a newbie professor.

Michael Mitzenmacher said...

Anon #5: You do realize, to a significant extent, this is already what Harvard (and many other private schools) in fact do; they set high tuitions, but then "lower" them for many through financial aid.

However, I think you overestimate the price inelasticity of tuition charges. We do have a number of competitors, and there are already large public/political complaints about tuition increases larger than the inflation rate (even though financial aid, at least at Harvard, has tried to make up for that). I just personally doubt Harvard could do what you suggest, for economic and political reasons.

A better approach, I think, is not to "tax the rich" on the way in by tuition, but on the way out -- get them to contribute to Harvard afterward!

Anonymous said...

from anon #5 again:

I suggested that student aid is an artificial expense to at least some extent, and it seems you agree. So why do you still count student aid as endowment spending - when at least part of it is artificial?

Michael Mitzenmacher said...

Anon #5 -- No, I don't think financial aid is an artificial expense, and it's not clear to me what you mean by that.

Harvard costs money to run. Part of that money comes from charging students. Other parts come from the endowment.

Harvard has some flexibility in setting its budget and determining how much comes from each of these pieces. It also has some flexibility in pricing, but it is subject to market pressures.

Harvard also sets priorities in its goals as an educational institution. In recent times, it has expanded its goal to seek out talent and admit students from the lower socioeconomic quantiles. This has costs, which have to come from somewhere. We agree that they could do this by raising tuition on those who could pay it (price discrimination), but that would have, as I pointed out, its own implications that make it unappealing and potentially infeasible. So the costs come from the endowment. But we are talking real money, so I just don't see your point.

Russ Ross said...

It's hard to criticise you too much, because I ended up following your example—begin too hard and scary at first while I learned to calibrate my expectations.

Of course, many of my students probably say that I need further calibration…

Anonymous said...

My (large) university spends 4.5% of its endowment per year. An economist friend of mine has argued that this is in some ways stupid, and that we ought to put a, say, 20-year term on the life of any specific donation (in which case you'd probably spend 6% to 8% per year) ... since in 100 years a $1 million endowed chair position may be worthless due to inflation.

Unknown said...

Whenever a budget is unimaginably large, folks think that there's more than enough leeway to pay for their pet project, be it as small as a having a grad student for a TCS project courtesy of university funds or as large as providing robust health care plans for all Americans courtesy of the federal government. But budgets often don't safely allow such actions; "A billion here, a billion there, pretty soon it adds up to real money." Thanks for crunching the numbers to show that the money's not there.

Anonymous said...

anon #5 nitpicking again...

What I meant to say is that the amount of the student aid you computed is a function of the "tuition" which is kind of arbitrarily defined. You could define "tuition" to be 60K per year without actually charging a different amount from any student, and tell yourself you significantly increased student aid. I was not suggesting actually raising tuition (except perhaps for some small percentage of very rich students to make the example less artificial).

Michael Mitzenmacher said...

Anon #5: And my point is that, while I agree that you can play with these numbers, the numbers do represent something -- actual inlays and outlays of money by the university. So if you artificially change the income in, you have to change out output out to keep the effect on the budget neutral.

If I'm interpreting you correctly, you mean we could increase the tuition by $10,000 a year, give EVERY student an automatic $10,000 in financial aid, and have no actual change in the budget while making our "financial aid" number look bigger. Of course since there's no change in the budget, this wouldn't change the fact that we'd need the same amount of money from the endowment to cover expenses. But I agree it would change the "percentage" results of my calculation.

Hence I would agree with you that my calculation was artificial if Harvard did something like that -- that is, if the tuition number was artificially created out of thin air in order to come up with a desired financial aid number. But Harvard's tuition rates are essentially in line with its peer institutions, so this is not the case.

We can start a different way if you like. What is the FAS budget? I'd have to look it up, but my back of the envelope calculation is about 1 billion, with about 40% coming from the endowment (before financial aid), about 30% from tuition and other student fees (before financial aid), about 20% or so from sponsored research, and about 10% from other sources (gifts for current use, licensing, etc.). Those fractions are very approximate; I don't have the numbers in front of me. Harvard's using the endowment to cut tuition from about 30% to 15% of the budget. I don't think there's anything artificial about that.

Elliot said...

After reading your blog, I found out I was misinformed about FAFSA, and thought I didn't qualify.
Ironically, how information gets misinformed, thanks to your article I went ahead and applied for FAFSA sucessfully.
I hope to receiving financial aid for my courses soon.

Thank you!
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