Public universities have declined in quality relative to private universities over the past fifty years.  Given the college earnings premium (60 to 70 percent more than high school graduates on average), and that two thirds of America’s college students attend public universities, this decline warrants concern.  Surprisingly Medicaid, the government health insurance program for low income and disabled Americans, may be responsible, as a 2005 study from the Brookings Institution argued.  The details illustrate how federal grants shape state policy.

First, the quality of state universities has declined.  Fifty years ago, seven state universities were in the top twenty of the U.S. News and World Report annual college rankings.  Recently only UC-Berkeley has seen the top twenty.  SAT scores show a decline in the relative quality of public university students.

Next, consider state spending.  Between 1985 and 2003, Medicaid increased from 8% to 18% of state spending (and is now over 20%), while higher education fell from over 7% to 5%.  Inflation-adjusted higher education spending per state resident has also fallen.  And states with the largest Medicaid spending increases, like Massachusetts and New York, have cut higher education the most.

State funding cuts have fueled tuition hikes at public universities.  The College Board’s net cost of attendance increased 54% faster than inflation at public universities over the past two decades, versus a 29% increase at private colleges.  State appropriations covered half of university budgets in 1980 but only one third by 2000.

Higher tuition, though, has not fully offset reduced appropriations.  The Brookings study documented declines in expenditures per student and faculty salaries at public universities, relative to private universities.  This connects the decline in quality to state spending.

Medicaid has been crowding out higher education because of the incentives for state governments created by the structure of federal support.  States run their own Medicaid programs, with over half of the money coming from Washington.  Medicaid uses matching grants, under which Washington matches each state dollar with $1 to $3 (lower income states get a better match).  And the match is open ended, so states get more federal dollars as they spend more.  State politicians can take credit for covering new treatments or new beneficiaries through Medicaid, with Washington subsidizing half or more of their generosity.  By contrast, federal financing offsets reduced higher education spending.  Federal financial aid responds to higher tuition, due to spending cuts, by providing students more assistance.

Suppose a state moves $1 from higher education to Medicaid.  State universities raise tuition, which might increase Federal student aid by perhaps $0.50.  The extra $1 spent on Medicaid brings in $1 or more in matching grants; $2 or more of Federal money could be captured.  State lawmakers face this incentive to reallocate spending year after year.  Alabama’s earmarking of taxes to General and Education Trust funds reduces this incentive somewhat.

Guaranteed student loans, which now exceed $1.3 trillion and are producing calls for forgiveness or free college, are one element of Federal student aid.  So Medicaid and the student loan problem are linked.

Medicaid can also wreck state finances during recessions.  State tax collections generally fall during recessions.  For instance, Alabama’s income tax and sales tax revenues fell 12% and 10% respectively in 2009 (the depths of the Great Recession).  Medicaid is an entitlement program, meaning that spending increases automatically if more people meet the eligibility criteria and enroll, like when unemployment rises.  A recession increases Medicaid spending when state revenues tank.  Since every state except Vermont has a balanced budget rule, Medicaid worsens state budget crises, which often yield tax hikes that subsequently slow economic growth.

Medicaid was not intended to harm America’s public universities, but government programs can produce unintended consequences.  Block grants provide an alternative to open-ended matching grants to distribute Medicaid dollars to states.  Block grants eliminate the incentive for continual expansion.  In addition to controlling spending growth and improving the quality of care for low income Americans, which I recently discussed, block grants for Medicaid could also help out our public universities.

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision.  The opinions expressed in this column are the author’s alone and do not necessarily reflect the views of Troy University.