Working Paper: NBER ID: w28669
Authors: Kristy Fan; Tyler J. Fisher; Andrew A. Samwick
Abstract: Financial aid programs enable students from families with fewer financial resources to pay less to attend college than other students from families with greater financial resources. When income is uncertain, a means-tested financial aid formula that requires more of an Expected Family Contribution (EFC) when income and assets are high and less of an EFC when income and assets are low provides insurance against that uncertainty. Using a stochastic, life-cycle model of consumption and labor supply, we show that the insurance value of financial aid is substantial. Across a range of parameterizations, we calculate that financial aid would have to increase by enough to reduce the net cost of attendance by 30 to 80 percent to compensate families for the loss of the income- and asset-contingent elements of the current formula. This compensating variation is net of the negative welfare consequences of the disincentives to work and save inherent in the means-testing of financial aid. Replacing just the "financial aid tax" on assets with a lump sum would also reduce welfare.
Keywords: financial aid; insurance value; income uncertainty; college costs
JEL Codes: D15; G52; I22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| financial aid increases by 30% to 80% (I22) | compensates for loss of insurance value (G52) |
| a dollar of financial aid through existing formula (I22) | worth $1.44 in lump-sum tuition discounts (H43) |
| removing asset tax (H26) | 44% reduction in average EFC (I24) |
| inclusion of assets in financial aid calculation (D14) | incremental insurance beyond current income (G52) |
| mean-testing financial aid (I22) | disincentives to work and save (E21) |
| current financial aid formula (I22) | insurance against income uncertainty (G52) |