The Federal Student Aid Process is Not Efficient

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Nearly all of the variation in aid to students is generated by only a handful of the more than 70 data items used in the current aid formula.

In Complexity and Targeting in Federal Student Aid: A Quantitative Analysis (NBER Working Paper No. 13801), co-authors Susan Dynarski and Judith Scott-Clayton write that the complexity and uncertainty in the federal system of financial aid for college students - primarily Pell Grants and Stafford Loans - undermine its efficacy, while doing little to improve the targeting of loans and grants to those who need them most. They also suggest that targeting aid to the neediest students can be achieved with a much simpler process. The current system is so complicated that families cannot predict their aid (the authors refer to this as "uncertainty") - for students from low-income families, this could mean not applying to college at all.

Ten million individuals annually seek federal aid for college. They are required to complete the Free Application for Federal Student Aid (FAFSA), which at five pages and 127 questions is slightly longer than the IRS Form 1040 (and substantially longer than the 1040EZ and 1040A) used for federal income tax returns. The authors estimate that it takes ten hours on average to complete the FAFSA: at $17.50/hour (the current average hourly wage), that adds up to $1.75 billion/year. Plus, colleges spend over $2 billion/year on salaries for staff who administer federal financial aid, or other aid based on the federal formula.

Colleges also are required by statute to audit at least 30 percent of these aid applications - at least 3 million such audits take place annually. Dynarski and Scott-Clayton estimate that the compliance costs faced by applicants and the administrative costs borne by the government and colleges total at least $4 billion/year. The true social cost is even higher, they conjecture, because complexity and uncertainty may discourage the target population from applying for student aid.

Pell grants average $2500/recipient, with a maximum value of $4,050. They go almost exclusively to families with incomes below $40,000. During the 2004-5 academic year, $13.6 billion in Pell grants was delivered to over 5 million students. Another $55 billion was disbursed via Stafford Loans, half of which are need-based (and the government pays the interest while the student is in college) and half "unsubsidized" so that the interest accrues during college.

Nearly all of the variation in aid to students is generated by only a handful of the more than 70 data items used in the current aid formula, the authors find. Adjusted Gross Income (or earnings, for those who don't file federal income tax forms), marital status, family size, and the number of family members in college explain over three-quarters of the variation in federal grant aid. For 75 percent of applicants, using a simplified formula that includes only a subset of income items rather than the full list in the FAFSA produces grants within $100 of those generated by the current formula. The same is true for loans (which also require the FAFSA form).

This paper expands on earlier work by the authors, also directed at simplification, by including loans as well as grants and independent students (older than 24, or married or with children). Those independent students now comprise 47 percent of undergraduates and receive 58 percent of Pell Grant funds and 56 percent of Stafford subsidized loan dollars. The authors use individual-level data from a 2003-4 National Postsecondary Student Aid Survey - their sample is 26,156 full-time undergraduates who attended the same institution for the full year.

-- Donna Zerwitz