While designing a webtool that provides potential college students with an estimate of their financial aid, I learned a few crazy things.
# 1 is here.
#2: Student earnings and assets are “taxed” at an unreasonably high rate by the aid formula.
It should be fairly uncontroversial that saving money for college is a good thing. Similarly, working over summers to earn money for college should be thought of as a good thing. Yet the aid formula discourages both too much.
This is easiest to see with independent students without any dependents, say a 25 year old enrolling in college for the first time.
To see how work is discouraged, starting from the default settings of the webtool, select this year, increase the student’s age to 25, and then increase earnings to $16,000. Such a student would have an EFC (EFC stands for Expected Family Contribution, and it is what the government thinks your family can afford to pay for college) of $2,000, a Pell grant of $3,700, and a price after aid of $100. If the student earns an extra $800, EFC increases to $2,300, their Pell grant is reduced to $3,400, and their price after aid increases to $500.
In other words, the student’s is rewarded for earning an extra $800 by having their Pell grant cut by $300 and having their price after aid increase by $400. This discourages such a student from working to earn that extra $800.
To see how saving for college is discouraged, from the default settings of the webtool, select this academic year, increase the age to 25, and increase assets to $12,500. Such a student would have an EFC of $1,900, and a Pell grant of $3,900, and a $0 price after aid (student loans cover the rest of the cost). Now increase assets by $1,000 to $13,500. The student now has an EFC of $2,100, a Pell grant of $3,700, and a $200 price after aid. This means that there is essentially a 20% tax on student assets (every $5 increase in assets will reduce aid eligibility by $1). A 20% tax may not seem that high, but remember that it is applied each year. Assuming the student pays the extra $200 in price after aid out of assets, there is $800 of the original $1,000 left the second year, and this will reduce aid eligibility by $160 for the second year. There would be $640 left in the third year, reducing aid in year three by $128. The $512 left in year four would reduce aid eligibility by $102.40.
To sum up, students like this are “rewarded” for saving an extra $1,000 with a reduction in Pell grants over four years of $590.40.
Since these high “tax” rates discourage working and saving for college, the financial aid formulas should be modified to tax these activities at a much lower rate.