Assessing the College Financial Aid Work Penalty

ABSTRACT

Working has become commonplace among college students in the United States; however, this activity can have unexpected financial consequences. Federal formulas implicitly tax the amount of financial aid some students are eligible to receive by as much as 50 cents for each marginal dollar of income. In this article, I document this college financial aid “work penalty” and discuss the related incentives for some college students to reduce their income. Using data from a national sample of financially independent college students in the United States, I did not find evidence to suggest that students meaningfully reduce earnings because of implicit taxes. Lack of knowledge, abstruse formulas, and the timing of aid receipt likely limit responses. The reduction in aid has the potential to burden low-income students who need to both work and receive financial aid to afford college expenses.

KEYWORDS:

• College financial aid
• educational finance
• implicit taxes
• working students

Acknowledgments

The author thanks Sandy Baum, Ron Ehrenberg, Mark Long, Michael Olivas, Amaury Nora, and numerous seminar participants for helpful comments, as well as Michael Laughlin for research assistance.

Funding

I gratefully acknowledge research support for this project from the W. E. Upjohn Institute for Employment Research; all opinions and errors are my own.

Supplementary

Supplemental files are available online http://hdl.handle.net/1811/79918.

Notes

^1. For example, the higher education goals of the Obama Administration include increasing college completion among nontraditional working students (The White House, n.d.http://www.whitehouse.gov/issues/education/higher-education).

^2. Additionally, all graduate students (nearly 3 million students annually) are considered independent (U.S. Department of Education, 2013).

^3. This finding is particularly true since home equity was removed from consideration in aid formulas as part of amendments to the Higher Education Act in 1992.

^4. States also heavily subsidize higher education costs at public institutions, but students do not need to apply for the majority of this aid because it is reflected in subsidized tuition prices.

^5. The EFC calculation guide is available at http://ifap.ed.gov/ifap/byAwardYear.jsp?type=efcformulaguide. Income is based on adjusted gross income from the prior-year tax filing, plus untaxed income and benefits.

^6. Independent students with dependents other than a spouse can qualify for an “automatic zero” EFC if they satisfy various conditions. See http://ifap.ed.gov/ifap/byAwardYear.jsp?type=efcformulaguide.

^7. If not all need is met by financial aid, then the amount of out-of-pocket expenses that would vary with aid would decline. As a result, we would expect less of a response to implicit taxes because there would be less forgone aid with each marginal dollar of earnings. Additionally, for ease of exposition in this section, I assume that institutions determine need in a manner generally similar to the federal needs analysis formula. This simplifying assumption is needed because it would be extremely difficult to individually describe how each of the thousands of schools in the sample idiosyncratically assign aid. Nonetheless, it is likely that students will respond to incentives in all relevant aid formulas, if they respond at all. Students’ ability to respond also likely weakens in situations where they need to navigate multiple complex needs formulas, as discussed in the following section.

^8. Because of informational and computational issues described later, it is possible that some students with incomes outside of these ranges may also respond to implicit taxes if they reduce their work effort in response to the general concern that they could lose some financial aid. I cannot formally analyze such general behavior using the data in this study.

^9. The minimum Pell Grant award amount is typically 10% of the maximum award amount for that year. Thus, the maximum EFC a Pell-eligible student can have is typically the maximum Pell Grant amount for that year minus the minimum Pell Grant award amount. However, in the 2011–2012 school year, students who were eligible for at least 5% of the total maximum were eligible for the minimum award, such that the maximum Pell-eligible EFC was $5,273.

^10. Aid packages vary by student and by institution. Federal loan programs have annual and/or aggregate limits and the generosity of some federal programs such as work study depends on school-level fund availability. Work-study funds are also contingent on a student’s ability to obtain an applicable job. There are also state and institution aid programs available to some students.

^11. Needs analysis based on prior prior-year tax returns will add further separation between students’ working behavior and their ability to respond to implicit taxes.

^12. Estimates using ordinary least squares estimates and Cragg’s hurdle models led to qualitatively similar conclusions and are available upon request.

^13. First-year students’ prior-year incomes were from a period prior to the students entering college, whereas returning students’ prior-year incomes were from a period when the students were enrolled in college and therefore could already incorporate learning about the financial aid system.

^14. Current-year income data were self-reported and do not include earnings from summer employment or from the student’s spouse. Prior-year earnings in the data were based on total household earnings from official FAFSA filings.

^15. All figures in this paragraph come from the author’s calculations using NPSAS 2008 and 2012 data.

^16. Another contributing factor to the lack of response is that incentives relevant to other social programs or the income tax system may have more pronounced effects. Results from studies of federal education tax credits have revealed little effect of these credits on students’ enrollment decisions; rather, they predominantly subsidize costs for students who would have otherwise enrolled (e.g., Turner, 2012).