This is one in a series of 15 two-page, evidence-based framing memos on pressing education and social issues prepared by MDRC for the incoming Obama Administration and the new Congress.

Bottom Line

Education pays: People with bachelor’s degrees earn over 60 percent more in their lifetimes than people with a high school education. The nation’s industries demand an educated workforce that can keep up with changes in technology and compete in the global marketplace. Strengthening and streamlining financial aid may increase rates of college attendance and completion.

The federal role: Since 1965, the federal government’s primary role in higher education has been to provide financial aid to low-income students. The Pell Grant program, currently funded at over $16 billion a year, awards grants up to $4,731 per year to help cover college expenses for the neediest students. The average grant is $2,945 per year. The federal government supports college students and their families by backing student loans and offering tax breaks for tuition and other expenses. In recent years, federal grant aid has declined in real terms, and more students depend on loans to finance their education.

The need for reform: There is broad consensus that the current financial aid system could be improved. First, the Pell Grant program has not kept up with real increases in college costs. The average cost of a four-year public college in 2008-09 was more than $6,500, and this figure does not take into account living expenses. Second, the funding formula used to award Pell Grants makes it difficult for nontraditional students, especially part-time students who are working, to qualify for grants. Third, the application process — known as the Free Application for Federal Student Aid (FAFSA) — is onerous and discourages many students and families from seeking aid. Fourth, federal income tax credits are confusing and do not benefit the lowest-income households.

Major proposals: A number of suggestions for improving the financial aid system have been proposed by bipartisan panels and policy experts, including the Commission on the Future of Higher Education and the College Board. Major recommendations include the following:

• Increase Pell Grant funding. Pell Grants are the single most important source of grant aid to low-income students but have not kept pace with the cost of attendance at most institutions. Moreover, the annual appropriation limits the size of the awards students receive. An increase in the annual appropriation for Pell Grants would enable more students to receive the maximum award. Some experts have proposed linking the maximum Pell Grant to changes in the Consumer Price Index.
  
  
• Simplify the process of applying for financial aid. Virtually all the information needed to determine financial aid eligibility is available through the federal income tax form. Many experts believe the current FAFSA could be eliminated altogether or reduced to just a handful of questions if it were linked to the tax form. Low-income households could be notified of their potential eligibility for financial aid after filing.
  
  
• Consolidate federal financial aid programs. There are currently about 20 separate programs and tax credits that offer financial support to low- and middle-income students. Consolidating these programs could reduce confusion, lower administrative costs, and free up funds to serve the lowest-income students.

What Do We Know?

Given the large amount of money spent on financial aid, there is surprisingly little research on its effects. Surveys and qualitative studies indicate that low-income students are anxious about how to pay for college and are averse to loans, perhaps because they are uncertain that their education will pay off in the future. Economic models suggest that students respond positively to reductions in the cost of college attendance, whether due to grants or lowered tuition. Specifically, college attendance goes up 3 to 4 percentage points for each $1,000 reduction in the amount students have to pay.

In a random assignment study of a “performance-based” scholarship conducted by MDRC, a group of low-income parents attending community college in Louisiana received $1,000 on top of Pell Grants if they met two conditions: they stayed enrolled at least half-time and they maintained a “C” or better grade point average. The scholarship was offered over two semesters, offering $2,000 in total. MDRC found that students who received the performance-based scholarship showed significantly higher rates of registering in college and making progress toward degrees than students in a control group.

Key Choices

Simplifying the FAFSA and consolidating federal financial aid programs could be undertaken by the new Administration fairly quickly and would not require major new outlays of funds. It might be prudent for the Administration to conduct small pilot tests before implementing such policies nationwide. A simplification of the financial aid application process, for example, could lead to a significant increase in the number of low-income students who apply for aid and enroll in college. This outcome, while positive, could have significant budgetary consequences. Increasing Pell Grant funding or other financial programs would obviously require Congressional approval.

The Administration might also consider testing innovations like performance-based scholarships. MDRC launched a multi-state demonstration of this idea in 2008 to study several variations of the intervention with principal support from the Bill and Melinda Gates Foundation. In addition, the recently enacted reauthorization of the Higher Education Opportunity Act (P.L. 110-315) includes demonstration authority for a study of performance-based scholarships.

Key References

The Rethinking Student Aid Study Group. 2008. Fulfilling the Commitment: Recommendations for Reforming Federal Student Aid. New York: The College Board.

Dynarski, Susan. 2003. "Does Aid Matter? Measuring the Effect of Student Aid on College Attendance and Completion." The American Economic Review, 93(1), 279-288.

Richburg-Hayes, L., Brock, T., LeBlanc, A., Paxson, C., and Rouse, C. Forthcoming. Opening Doors to Persistence: Results of a Community College Scholarship Program for Low-Income Parents. New York, NY: MDRC.

U.S. Department of Education. 2006. A Test of Leadership: Charting the Future of U.S. Higher Education. Washington, DC: Author.