Missed Opportunities on Financial Aid

February 13, 2007

With support for postsecondary education now a hot political topic, federal politicians from both parties are engaged in a tug of war to see who can outbid the other in providing more financial aid to students and their families.  House Democrats, as part of their “first 100 hours” agenda, pushed through a bill to cut interest rates in half for some new borrowers. Democrats in both the House and Senate followed up by proposing the first increase in the Pell Grant maximum award in several years. The White House, not to be outdone, has now proposed more than a 10 percent increase in Pell Grants as part of its fiscal 2008 budget package and more increases down the line, all to be paid for by reduced lender profits and cuts in other federal student aid programs.

Unfortunately, each of these well-intentioned efforts won’t do much good for the students who most need the help and possibly could do a fair amount of harm, by using increased funding for aid in largely ineffective ways while letting much greater needs go unmet.

Why the pessimism? Isn’t any increase in Pell Grants or cut in interest rates a good thing? Not necessarily. Take the proposed halving of the interest rates, a plan flawed for several reasons. First, paying for such benefits by making a series of cuts in government payments to lenders will eventually reduce lender willingness to participate in the federal student loan programs and/or increase their efforts to pass these costs along to all borrowers.

More importantly, the Democrats’ plan helps the wrong borrowers. The interest rate cuts are limited to new borrowers in the subsidized student loan program, who, by definition, already qualify for federal interest payments while they are in school. As a result, they are precisely the students who least need the assistance in the near term, because the federal government is already paying the interest on their loans (which also means there is no net cost to the government while these borrowers remain in college, since it is already responsible during that time for making all interest payments to lenders). In this scenario, the students’ benefit from lower interest rates and the new cost to the government will occur only when repayment begins at least several years from now.

By contrast, the House-passed legislation provides no help for the millions of borrowers who are currently having trouble repaying their loans because of high debt levels and/or low incomes.  It would have been much better if the House had sought to help these borrowers, for example, by allowing them to consolidate all their federal student loans into a single loan repayment schedule when they leave school and begin repayment. This expansion of existing consolidation provisions would greatly simplify the student loan system by allowing borrowers to refinance their student loans once they leave school.

Or the House could have sought to expand the largely underutilized income contingent provisions that give borrowers the option to repay their loans on the basis of their income once they complete their educational program. Rather than provide postponed help for new borrowers, these two changes would provide immediate relief for millions of borrowers who need the help now. And these two changes could actually save the government money rather than add to costs if they were financed directly by the federal government rather than having the loans continue to be held by the private sector which demands federal payments over the life of the loan.

Senator Edward M. Kennedy of Massachusetts, the newly restored chairman of the Senate Health, Education, Labor and Pensions Committee, seems to understand this problem. He has emphasized the need to expand income contingency for borrowers who need help with their repayments and in moving toward greater reliance on direct loans as a way to cut government costs. Hopefully, he can persuade his colleagues in the Senate to provide some real repayment relief to borrowers rather than the cosmetics offered by the House. Otherwise borrowers with repayment problems will be out of luck for another several years until the politicians turn their attention back to this issue.

The case of political competition over proposed Pell Grant increases is no more reassuring. While increasing the maximum award after years of stagnation is politically appealing, it is not clear how much good it will do for students from the lowest income families. Why not? For one, the way the Pell award formula works, when the maximum award is increased, many new students with family incomes above $40,000 will become eligible for small awards. Of the roughly $400 million now required to raise the Pell maximum award by $100, as much as a third or more will go to fund these new awardees.  While this is certainly a political plus, these small awards won’t do much to affect their enrollment decisions.

Of greater concern is what institutions that package aid will do in reaction to Pell Grant increases.  Will the infusion of funds into the Pell program lead institutions to cut back on what Pell Grant recipients are asked to borrow? Or will they rely on the larger Pell awards to carry the burden of providing greater access to college for low income students by reducing the discounts they give these students by the amount of the Pell increase, thereby blunting the effect of the Pell Grant increase who need the aid the most?

This brings to mind the last time Pell Grants were increased by a large percentage in the late 1990s, as the Clinton administration sought to gain support for its tuition tax credits by increasing Pell Grant funding at the same time, and the Republican Congress went along. Data from the National Postsecondary Student Aid Survey (NPSAS) indicates that this is precisely when the pattern of institutional aid changed sharply, with more and more institutional discounts being awarded to middle income and even upper income students.  If this pattern occurs again if Pell funding is expanded, the result could be small overall increases in grant awards for the lowest income students and bigger increases in the aid packages for middle-income students.  This is certainly not the desired result.

Rather than greatly expand the number of Pell Grant recipients, a better approach would be to target increased awards on the lowest income students.  This would require changing the award rules to reduce Pell eligibility for students with families not in the lowest income quartile (now roughly $35,000 for a family of four, compared to median family income of $65,000).  To the extent that most of these families pay taxes, the amount of support they receive could be increased substantially by including expanded tuition tax credits into whatever tax cut package emerges in this Congress.  

Specifically, the two existing federal tuition tax credits and tuition deduction could be expanded and consolidated into a single tuition tax credit that provides greater benefits for postsecondary charges than the much more modest amount of Pell Grant most of these students would receive under the contemplated augmented funding of Pell.  This set of changes would allow Pell Grants to focus more on those students who are most at-risk, while making a new expanded tuition tax credit the primary source of non-repayable assistance for middle income students and lifetime learners already in the work force.

A portion of the funds that would have been used to increase Pell Grant funding also could be used in much more constructive ways. Available research suggests that more funds for early intervention programs such as the Gear Up program would be more effective in raising the aspirations and improving the preparation of the most at-risk students than are Pell Grant increases that get spread across many more students from a much broader range of incomes. Or some of these funds could be better used to address the gnawing student success problem of low degree completion rates by paying institutions for the Pell Grant recipients that enroll and receive a degree, providing a much needed incentive for institutions to recruit, support and graduate these students.

Such an incentive could substitute for the formulas currently used to distribute funds in the Supplemental Educational Opportunity Grant and Leveraging Educational Assistance Partnership Programs that the Bush administration proposes to eliminate as a way to pay for Pell funding increases. The private college associations and others are arguing against these funding cuts in SEOG and LEAP but, truth be told, they currently either favor institutions with large endowments that don’t need the money to help low income students or provide a small match to the roughly $5 billion that states already use to pay for need-based awards. A formula that rewards institutions and states that do a better job in recruiting and graduating Pell Grant recipients would be money much better spent.

Thus far the debate over helping college students has been an example of good politics trumping good policy. Hopefully, greater rationality will prevail as the House legislation and President Bush’s budget proposals wend their way through the legislative and appropriations process, with the end result being that assistance will be directed to the millions of current and future borrowers who really need repayment relief now from their student debt burdens, as well as the millions of students and families who continue to need help in paying for their education.


Arthur M. Hauptman is a public policy consultant specializing in higher education finance issues.

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