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.
Authors
- Acknowledgements & Disclosure
- We thank Martin Boyer, Scott Carrell, Elizabeth Cascio, Susan Dynarski, Glenn Harrison, Jason Houle, Annamaria Lusardi, Jonathan Meer, Jonathan Skinner, and seminar participants at the Quantitative Society for Pensions and Savings Summer Workshop, the Boulder Summer Conference on Consumer Financial Decision Making, the Society of Labor Economists annual meeting, the Association for Education Finance and Policy annual conference, the CEAR-RSI Household Finance Workshop, the American Economics Association annual meeting, Middlebury College, and Southern Methodist University for helpful comments. We are grateful to Will Zhou, Raymond Chen, Madison Minsk, Sarah Hong, and Amy Hu for research assistance; to John Hudson for computational assistance; and to the James O. Freedman Presidential Scholars program and the Nancy P. Marion Academic Enrichment Fund at Dartmouth College for financial support. Any errors are our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
- DOI
- https://doi.org/10.3386/w28669
- Published in
- United States of America
