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WASHINGTON -- It’s been a nail-biting few years for Pell Grant advocates, as Congressional budget crisis after Congressional budget crisis raised the specter of deep cuts to the major federal financial aid program for low-income students.

But the next 18 months for the program may be among the most difficult yet. The Pell Grant is safe from the “fiscal cliff” -- the combination of scheduled tax increases that go into effect in January, and mandatory spending cuts that take effect if Congress does not reach a long-term debt deal. But the 113th Congress, which takes office in January, will have to confront two other financial aid funding crunches in the next year and a half.

The challenges are particularly acute this time around. After the switch from bank-based lending to direct lending for federal student loans in 2010 redirected much of the savings to the Pell Grant program, it appeared to be on solid financial ground for the next few years. But increased concern about the deficit, which led to the narrowly averted government shutdown in spring 2011 and the fight over increasing the debt ceiling a few months later, led to cuts in an attempt to drive down the cost of the $37 billion program.

Soon the program will face a $5.7 billion shortfall for the 2014 fiscal year, which officially begins in just under 11 months. At the end of the 2013 fiscal year (Sept. 30, 2013), part of its mandatory funding expires. The problem, higher education lobbyists and other observers here say, is that this time, much of the low-hanging fruit for cost-cutting in Pell itself and other programs -- from eligibility changes to cutbacks in subsidized loans -- has already been used to fill budget gaps in the past.

An additional wrinkle: the interest rate on subsidized student loans will double to 6.8 percent July 1, an increase Congress and the White House staved off this year at a cost of $6 billion. Most here consider keeping both the interest rate at 3.4 percent and filling the Pell shortfall to be highly unlikely.

Sustaining the kind of cut that a $6 billion shortfall would require is not a palatable option for the Obama administration, which has fiercely defended the maximum grant; nor is it likely one for Congress. The funding gap could be filled in before the shortfall arrives, through other parts of the budgeting process. But most expect that changes of some kind will have to be made to the Pell Grant program -- and see either crisis or an opportunity to reshape financial aid.

In order to keep the maximum grant at its highest level, the past funding crises were solved by a combination of eligibility cuts -- the largest change reducing students’ number of eligible semesters from 18 to 12 -- and cutbacks to the subsidized student loan program, in which loans for financially needy students are interest-free while they are enrolled in college.

But few obvious eligibility changes remain, and the changes are getting increasing pushback from community colleges, whose students are among the hardest-hit. The subsidized loan program, too, has been trimmed down to its bones: the loans are now only available for undergraduate students, and there is no longer a grace period after they leave college and before they enter repayment.

Changes to Subsidized Loans

Congress could find the funding at least for another year or two -- by allowing student loan interest rates to double, as they are scheduled to do, or by cutting from other parts of the federal budget rather than other financial aid programs.

Changes to subsidized loans, though, are considered more likely. One option could be ending the interest subsidy but lowering interest rates on loans over all by tying the rates to yields on U.S. Treasury bonds. Senator Tom Coburn, an Oklahoma Republican, and Senator Richard Burr, a North Carolina Republican, proposed such a switch in July in a bill that would set the interest rate at bond yields plus 3 percentage points. The interest rate would change from year to year as new loans are issued each year, but would not vary over the life of a loan.

In June, the Congressional Budget Office estimated that that change would save $50 billion over 10 years.

The growth of income-based student loan repayment could also bolster the case for ending, or cutting back, subsidized loans. The interest subsidy makes borrowing less expensive for students in the long term, but income-based repayment -- which the Obama administration recently made more generous -- is emerging as the preferred way to help students manage their debt.

Ending subsidized loans could also simplify the distribution of federal student aid. Middle-income students are more likely to receive subsidized loans than Pell Grants, and determining whether or not they are eligible leads to a more complicated application process, said Sandy Baum, a higher education policy analyst who studies financial aid.

Although there's a growing consensus among policy researchers that subsidized loan expenditures could be better used elsewhere, the loans have many supporters among higher education officials. Private colleges, especially, say their students depend on the loans because they reduce the cost they must pay in the long term.
Even subsidized loans are a moneymaker for the federal government under the current accounting system, notes Sarah Flanagan, vice president for government relations and policy at the National Association of Independent Colleges and Universities. Whether or not additional cuts are made depends on political will. The White House had not been willing to cut the interest subsidy for undergraduates in the past.

In a blog post Thursday, Jason Delisle and Alex Holt of the New America Foundation’s Federal Education Budget Project argued that the new, more generous income-based repayment program -- which allows students to put 10 percent of their monthly discretionary income toward their loans -- makes subsidized loans “obsolete.”

“With the availability of New IBR, Subsidized Stafford loans provide no additional aid to borrowers who need it most, while reducing payments for borrowers who are not struggling to repay,” Delisle and Holt wrote, arguing that lawmakers should end the subsidized loan benefit and instead use the money to help the Pell Grant program.

A Pell Grant Overhaul?

Changing or ending federally subsidized loans might be enough to fix the $6 billion shortfall, but a push to rethink the Pell Grant’s uses and purpose has also been building. The Gates Foundation is funding a fast-track effort on how to use financial aid to encourage students to complete college; recommendations are expected in February, about the time President Obama will release his 2014 budget request, which presumably will include a way to deal with the Pell shortfall.

“Maybe it’ll just limp along and we’ll find the money for the shortfall and we’ll keep going, but it’s not feasible” in the long term, Baum said.

Baum said she would favor one change to eligibility rules: requiring students to continue to show satisfactory progress even if they transfer from one institution to another, rather than being able to transfer once they’re on academic probation and begin receiving the grants again. But in general, she said, the Pell Grant’s place in the financial aid and job-training ecosystem might need to be rethought -- a conversation that is not as much about saving money as about making the program more effective and efficient.

“We’re asking this program to do so much more than we were asking it to do before,” Baum said. The program serves students with many different types of needs -- traditional-age students in full-time general education programs, adult students in vocational programs, etc. -- and the program might be restructured so that it serves different groups of students in different ways. (Note: This article has been updated from an earlier version to clarify Baum's comments.)

Sara Goldrick-Rab, an associate professor of education policy studies and sociology at the University of Wisconsin at Madison, said that most of the eligibility changes Congress has made so far in order to preserve the maximum grant have had little basis in research. For the most part, she said, they were “reactive and detrimental to the overall message that we want to use aid to make decisions,” Goldrick-Rab said. “They look like acts of desperation rather than acts of good public policy.”

But she said her research, a longitudinal study of state grant recipients, suggested that need-based grants might not be able to be used to encourage completion until colleges use them to supplement, rather than supplant, institutional and state aid.

“I think it should be tied to behaviors of states and institutions,” Goldrick-Rab said of the grant funding. “I don’t think these tweaks to eligibility or targeting or anything like that makes any sense. Fundamentally, those are just going to be small tweaks at the end of the day.”

Large-scale changes, such as restructuring the program to treat students with different educational needs differently, as Baum suggested might be a possibility, or tying the grants to institutional or state funding for low-income students, as Goldrick-Rab recommended, would need to go through the Higher Education Act, the sweeping federal law governing financial aid programs. The law expires in 2013 (but will not be reauthorized on time, nor before the Pell shortfall needs to be addressed).

Even a year of a largely guaranteed Pell Grant -- funding for fiscal year 2013 is considered almost a sure thing -- is something of a rarity. But the challenges facing the program before the 2014 fiscal year will be difficult to resolve, lobbyists said.

“Between now and then we need to have some serious policy discussions,” said Cynthia Littlefield, vice president for federal relations at the Association of Jesuit Colleges and Universities. “It’s not like there is a pot of money to tap for Pell Grants. There isn’t.”

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