The cost of higher education remains unaffordable to so many students because colleges and universities “capture” the benefits of financial aid (federal grants, veterans benefits, state grants and private grants) by increasing tuition and fees, argues a recent report, “How College Pricing Undermines Financial Aid,” issued by the Center for College Affordability and Productivity.

The authors identify a little appreciated mechanism that enable colleges and universities to charge what the market will bear: They possess information that players in other industries do not. They know how much their customers (students) can realistically afford to pay and how much external aid they receive from third parties. Armed with that information, they know how much they can increase tuition or lower their own grant aid without losing market share.

As prestige-maximizing institutions, universities are driven to increase spending. “Competition between institutions is driven by academic reputation,” the authors write. “Due to this persistent uncertainty, each institution must signal quality through expensive proxy signals, such as the quality of their students, research, facilities, or athletic teams. If an individual institution forgoes capturing increased financial aid dollars, it cannot compete; its status will decline as will its ability to attract good students. This behavior is reinforced by the fact that students and their parents associate high cost with high quality. … Higher education is engaged in an expenditure ―arms race that thwarts policies to increase public access and redistributes wealth to higher education insiders.”

Where does the money go? The authors cite the falling productivity and rising compensation for faculty as a major driver of costs. Over the past three decades, the faculty-wage component of cost per student rose by 33% among public institutions and 72% for private. At the same time, student-faculty ratios declined by 25% and 28% respectively. Evidence from other sources suggests that institutions of higher ed have experienced considerable administrative bloat as well.

There is reason to believe that Virginia’s institutions of higher education do deliver more bang for the educational buck than public institutions in other states. Yet tuition and fees are soaring here in Virginia as well. The usual college gambit is to blame insufficient state funding — which will take a big hit in FY 2012. But that excuse is wearing thin.