Subsidizing Enjoyable Education

We provide an explanation for why both college tuition and government grants to college students are typically means-tested. The critical idea is that attending college is both an investment good and a consumption good. The consumption benefit from education implies that, when tuition and grants are uniform, the marginal rich student is less smart than some poor people who choose not to attend college, thus reducing the social returns to education and increasing the college’s cost of education. Competition in the market for college education results in means-tested tuition. In addition, to maximize the social returns to education government should means-test grants. We thus provide a rationale for means-tested tuition and grants which relies neither on capital market imperfections nor on redistributive objectives.