Do bailouts of prepaid college plans subsidize the wealthy?

The economic collapse and the rapid rise of tuition have created a major squeeze for people who carefully planned for their childrens’ educational needs through state-sponsored prepaid tuition plans.  Technically, most of these plans did not come with guarantees, but were packaged as investment plans linked to tuition guarantees to which parents contributed on a regular basis.  Now, with funds running low and tuitions much higher than expected, parents facing the default of these plans want the states to bail them out.  But who benefits from a bailout, and who pays?  Jack Stripling of Inside Higher Ed analyzes the problem for USA Today:

It’s been a politically popular move for lawmakers to bail out prepaid college tuition plans that are now going broke, but doing so raises some potentially troubling questions of equity. Indeed, these bailouts could have the net impact of forgiving investment losses for middle- and upper-income families at the expense of low-income people, higher education researchers say.

It’s easy to understand why parents flocked to prepaid tuition plans, and it’s not surprising many of them are now crying foul. Parents say they reasonably assumed that paying into plans “guaranteed” their children would receive a college education, and they’re none too happy to hear state officials now say that investment losses and skyrocketing tuition increases have put the plans on a path toward insolvency.

The political and legal pressure to honor the plans has led a number of states to dig into greatly depleted coffers to bail out the programs. In so doing, states have made the calculation that those who were savvy enough to invest in prepaid plans — typically middle and upper income parents – are rightfully saved by money drawn from the state’s overall tax base, according to scholars who’ve studied the growth of prepaid programs.

“That means the people who can’t afford to go to college are going to be fundamentally underwriting the ability of the wealthy [to attend college],” said Michael Olivas, director of the Institute for Higher Education Law and Governance at the University of Houston. “It’s very regressive, extremely regressive, and in our society it seems to me it ought to be the wealthy who subsidize the poor going to college, not the reverse.”

The correct answer is probably closer to neither should subsidize the other.  Part of the problem with these plans is their very existence distorted the higher-education market, much like federal loan programs and grants do.  Just as with the effort to promote lending to marginally-qualified lenders in the housing market, the intervention created higher demand in a system that didn’t have the ability to expand supply as needed to meet it.  Prices therefore shot up much higher than inflation, creating a bubble that the static-analysis model for which these “prepaid” plans didn’t entire account — although the “prepaid” model used a price freeze as one of its key attractions.

The overall effect of this market distortion was to make college even more expensive, which impacts the working middle class the hardest.  Their children have a tougher time qualifying for the aid, but they don’t make enough to reasonably keep up with tuition costs.  Without scholarships, their children have to work their way through college, which isn’t bad life training, but it still puts them at a disadvantage.

Now the same families who benefit least from the government intervention will be asked to pay for the bailout of the prepaid plans.  Increased taxes won’t hit the poor, and the wealthy who mainly participated in these plans (average annual income for participants was over $100,000) will see much less impact on their discretionary income.

The question of who gets hit the hardest is really secondary in this case.  The primary question should be whether the states have any obligation to indemnify people for losses in investment programs where no guarantees existed in the first place.  It’s not an easy question, either, when the states are the ones who sold the plans to parents who wanted to save some money on tuition through these programs.  The better answer would have been to keep states from conducting this particular intervention in the first place.

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