Federal Aid for Postsecondary Students

The federal government supports postsecondary students through loan programs such as the William D. Ford Federal Direct Loan Program, grants such as those made by the Federal Pell Grant Program, and tax preferences such as the American Opportunity Tax Credit (AOTC). The amounts of support have varied in recent years, but in fiscal year 2017, the federal government financed roughly $100 billion in student loans and provided directly to students and their families $30 billion in need-based grants and $30 billion in income tax preferences, according to estimates by CBO and the staff of the Joint Committee on Taxation (JCT).

Higher education provides many benefits to students, including higher earnings, and to society, including increased tax receipts and reduced dependence on government assistance. But, in CBO’s view, there is no consensus on whether the current suite of federal programs and tax credits, or the amount of money devoted to them, provides too much or too little financial support for students. In this report, CBO examines some reasons why the federal government offers financial support to students and how the current system helps alleviate some of the challenges students encounter. CBO also considers several potential approaches to changing federal support.

Why Does the Federal Government Offer Student Aid?

Several barriers may deter some students from obtaining education that would benefit them and society as a whole:

• Students May Lack Access to Financing. Private loans for higher education can be expensive or unavailable, even when the associated degree would be expected to substantially increase the student’s income. That circumstance especially applies for students and families with a limited credit history or collateral.
• Benefits Are Uncertain. Higher education is a risky investment. Students may depart college without completing a degree, leaving them with expenses to repay and little financial benefit from their schooling. In addition, whether or not they complete a degree, students cannot predict their future earnings with certainty. Those risks may deter some people from pursuing higher education.
• Some Benefits Do Not Accrue to the Student. One person’s education may benefit others through higher taxes paid and lower rates of dependency, examples of what economists call positive externalities. But students may not incorporate those externalities in their decisions, so they may obtain less education than would be beneficial for society.

What Aid Does the Government Offer and What Is Its Impact?

The federal government offers loans, grants, and tax credits that address the economic barriers that students face.

Loans. Federal student loans provide financing to students and their families. The funds that loans provide probably encourage some students to acquire more or better education than they otherwise would. Yet many students still report that they cannot afford to enroll in college immediately after high school, suggesting that a lack of financing continues to impede some students’ access to higher education. And though federal student loans increase some students’ schooling options, the loans may increase students’ financial uncertainty because they generally must be repaid regardless of the students’ financial position after leaving school. To mitigate that uncertainty, the government offers repayment plans tied to eligible borrowers’ future income.

Grants. Grants subsidize higher education for students from low-income families. As a result, students receiving grants act as if they incorporated into their decisions some of the benefits that their education may provide for society. By reducing the cost, grants also reduce the amount that students must finance and reduce their uncertainty about whether their income after leaving school will be too low to justify the costs of school. However, grants may not result in students obtaining more or better education because students generally do not learn about their eligibility for or the size of their Pell grant until after they have applied to schools. Furthermore, the effective subsidy that the federal grants provide may be lessened if schools reduce their institutional grants to federal grant recipients. In addition, eligible students may find the application process cumbersome, which may discourage them from applying for a grant.

Tax Preferences. Tax preferences such as credits, deductions, and exclusions also subsidize education for students, including those whose family income is too high to qualify for federal grants. Like grants, tax preferences probably reduce the extent to which a lack of financing, uncertainty, and a failure to account for externalities present barriers to higher education. However, tax preferences probably have an even smaller effect on students’ behavior than grants, because the preferences are delivered well after decisions about school are made.

What Are Some Approaches to Changing Student Aid?

Policymakers are considering a variety of changes to federal student aid programs, so to assist them, CBO examined approaches that would address the three barriers to higher education described above. The approaches entail trade-offs between their effects on enrollment rates, completion rates, and the financial risk to which students are exposed. The approaches would affect federal costs as well, although CBO has not provided specific budgetary estimates. In brief, the approaches would do these things:

• Change How Much Financing Is Available. Approaches such as raising or lowering the borrowing limits on direct student loans or selling subsidized insurance to private lenders would change the amount of credit available to students and the amount they invest in higher education. Although increasing loan limits would provide more financing, it would also increase the risk that some students borrow more money than they are able to repay. Reducing loan limits would restrict access to financing but decrease that risk. Selling subsidized insurance to private lenders would have a similar impact to raising the borrowing limits on direct loans.
• Change the Uncertainty That Students Face. Approaches such as tightening the academic standards required for students to be eligible for federal support, tying the availability of loans at a school to its graduation rate, or giving the private sector greater incentive to guide students to financially rewarding programs could reduce the risk that some students would not be able to repay their loans. Alternatively, eliminating a program that forgives student debt after a certain amount of time would increase the risk that some students would not be able to repay their loans. However, that approach would reduce the cost to taxpayers.
• Change Subsidies. Approaches such as increasing the maximum Pell grant or providing additional grants to high-performing students from low-income families would induce students to act as if they incorporated more external benefits into their decisions about school. Those approaches would increase the fraction of students from low-income families who completed their degrees and would reduce the extent to which those students needed financing otherwise. Those kinds of increases in subsidies would also add costs to the federal budget. Changing subsidies by eliminating certain tax credits, which mostly go to middle-income students, would increase revenues for the federal government but slightly lessen the incentives for those students to obtain higher education.