Critics claim that public universities spend far too much on merit aid at a time when the focus should be on providing more need-based assistance, but the uses of merit aid are many, as are the reasons that drive the aid decisions at individual institutions.

The main problem for leading institutions, especially, is how to balance quality, access, state interests (including revenue), and public perception. In general, the most vocal critics of merit aid believe that access should trump all the other factors.

Two recent examples of that criticism come from the New America Foundation: Colleges’ Pursuit of Prestige and Revenue Is Hurting Low-Income Students and The Out of State Student Arms Race, both by analyst Stephen Burd.

First of all, some of the arguments in these and other reports are valid. For one thing, there is no doubt that the U.S. News rankings drive many colleges to spend money on generating better metrics, especially those related to test scores, selectivity, and student/faculty ratios. Some schools have become proficient in gaming the system.

The U.S. News methodology currently gives a combined weight of 9.25% to test scores and selection ratios. The use of the latter should be scrapped, given the increased use of the Common App and marketing geared to ramping up applications just for the sake of lowering acceptance ratios. (As for test scores, there are ways that colleges can game that metric as well.) The methodology also assigns a weight of 22.5% to multiple financial metrics that also pressure colleges to raise and spend more money.

State budget cuts and rising costs for instruction, research, and administration have also led to the need for more revenue. Just how much of the additional revenue is actually necessary for improved instruction is a matter of contention. (See for example Baumol’s Cost Disease and The Bowen Effect.) The combined effects of state disinvestment and the obsession with prestige and rankings have undoubtedly led to the intense focus on increasing revenues.

Yet after granting the critics a fair measure of credit, we come back to the four main factors that affect the allocation of merit aid, discussed below. And here’s a proposed standard for balancing the factors: If merit aid is denied to highly qualified, low-income students who are residents of the state, and goes instead to out-of-state students whose qualifications are about the same or less, then the merit aid is being used excessively for revenue purposes.

Quality–As noted elsewhere on this blog, the elite colleges and universities in this country, almost all of them private, simply do not have enough slots for the top 8-10% of students, based on test scores. Most of the highly talented students who are not accepted by elite private colleges will end up at public universities. Those public universities that allocate funds to support smaller classes and undergraduate research for talented students through honors programs, along with merit aid, are not only spending money to recruit students with higher test scores in order to enhance their prestige; they are also filling a real need by providing more slots for talented students. In addition, many are trying to keep talented students in state rather than seeing them leave, never to return. All too often, critics of public university spending ignore these needs.

Access–The relationship of merit aid to greater access for lower-income students is complex. Rankings and prestige have an impact on merit aid allocations, but that impact is not always what the critics see.

Some elite public universities (UC Berkeley, Michigan) offer higher percentages of merit aid than other public universities that are excellent but not so elite (although the average amounts of merit aid from Berkeley and Michigan are not especially large.) Why? The competition for UC Berkeley and Michigan includes many private elite schools, and sometimes even modest merit aid can be the deciding factor. Private universities such as Chicago, Northwestern, and Rice also offer significant merit aid, and do so to compete with the Ivies, Stanford, etc., who are so much in demand that they don’t have to offer non-need-based aid.

The University of Virginia and the University of North Carolina also compete effectively against private elites, but they have chosen to provide very limited merit aid.

For public universities at the next level, Washington, Illinois, UT Austin, Wisconsin, the competition is often with other publics, and they more than hold their own. Partly as a result of being in high demand regardless of aid, UT Austin has one of the highest enrollments of Pell Grant students and offers little in the way of merit aid.

But when it comes to public universities with lesser reputations than those listed above, the balance between aid for quality or aid for access may tip too far toward quality, sometimes with an eye on improving rankings and revenue. New America singles out the University of Alabama and the University of South Carolina for criticism. How much of this criticism is valid?

State Interests/Revenue–The state of South Carolina now funds only 10 percent of the cost of education at the flagship university. Moreover, the number of college-age students in the state is declining. New America criticizes the University of South Carolina for awarding too much merit aid to out-of-state students, who still end up providing more revenue out of pocket than in-state students, and also help to sustain enrollment levels.

If the university allocated most or almost all of its aid to need-based students within the state, the revenue would drop dramatically and the expense per student would rise. The university would probably be unable to support its excellent honors college; for that matter, the university would eventually be unable to serve as many students period. So even if the state legislature undervalues higher education, the university and many citizens believe it is in the interest of the state to increase the number of college graduates (and their families) over the long haul, and not diminish the university in the process.

Is the percentage of non-resident freshmen (45%) too high, and the merit aid they receive too much? To answer those questions, one would need to know (1) whether many highly qualified (but low-income) in-state students are not receiving aid because the aid is going to out-of-state students with equal or lesser qualifications; and (2) how many of talented out of state students will remain in South Carolina after graduation.  To the extent that highly qualified, low-income, in-state students are losing out, then the out  of state aid should be reduced.

Public Perception–Funding honors programs and offering merit aid to talented students can certainly increase the selectivity profile of a university and eventually enhance rankings and public perception. But we would draw a distinction between the aggressive gaming of the rankings and the more justifiable funding that is related to legitimate state interests. New America suggests that the extremely generous merit aid that the University of Alabama offers to talented out-of-state students is mainly to enhance rankings. But, contrary to what New America claims, the Alabama U.S. News ranking has actually fallen 13 places since 2012.

The University of Mississippi is another flagship that offers generous merit aid. What is also true is that the state of Mississippi has the second lowest percentage of college grads in the nation, and Alabama the 7th lowest. Surely these states should find ways to sustain their flagship institutions, and merit aid, for now, is one of those ways. Who knows but that some day they might join UVA, UNC Chapel Hill, UT Austin, Wisconsin and others that can go forward without so much emphasis on merit aid.

Again, we agree with New America that many universities, including some major public institutions, do use merit aid, at least in part, for purposes of moving up in college rankings and sometimes excessively for revenue purposes. But the total picture is much more complicated, resulting in one of the most difficult issues to emerge from state disinvestment in higher education.