Federal Financial Aid for Higher Education

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Section 1. Introduction

The federal government has played a leading role in encouraging students to obtain higher education. After World War II, the "GI bill" helped millions of veterans attend college. The Higher Education Act of 1965 and the Basic (now Pell) Grants program of 1972 provided aid to students from low-income families. Subsidized student loans became available on a widespread basis in the 1980's.

Over the past decade, higher education initiatives have shifted from spending programs to tax subsidies. Recent tax changes for higher education include the HOPE credit, the Lifetime Learning Credit, Section 529 plans for college saving, education IRAs, and the deduction for higher education expenses. Except for modest increases in the maximum Pell Grant and a broadening of the population receiving loan subsidies, virtually all of the new federal resources directed at higher education have been provided through the tax code and have been directed at students from middle- and upper-income families.

The evolution of federal education policy raises several concerns. First, trends in the labor market, college enrollment, and college costs suggest that both the need for and the benefits of higher education subsidies may have grown. The acquisition of higher education is broadly and appropriately viewed as a key mechanism for enhancing worker productivity, wages, and living standards. Despite the substantial private, and perhaps social, benefits of college attendance, enrollment rates have remained substantially lower among students from low- and moderate-income families than among students from high-income families. The continuing differential in enrollment rates limits both economic mobility and economic growth. The shift toward subsidizing education through the tax code, the dramatic growth in tuition at public universities, and the migration toward merit-based rather than need-based state and institutional awards, may all be exacerbating the gap in enrollment rates.

Second, the proliferation of so many different forms of assistance for higher education leads naturally to questions about redundancy, and overlapping or contradictory provisions. The net effects of the sum of the programs may be quite different from what could be expected from each program individually. Thus, analysis of federal education needs to proceed in an environment that examines the net effects of all the programs, taken together.

Third, the future of higher education policy has become increasingly intertwined with the status of federal tax and fiscal policy. Growing budget deficits fueled by tax cuts and spending on defense and entitlements, will create strong pressure to reduce education subsidies in the future. A variety of tax issues, from the scheduled repeal of the estate tax in 2010 to the projected explosive growth of the alternative minimum tax, will also adversely affect prospects for resources flowing to higher education.

This paper addresses a variety of issues regarding federal subsidies for college attendance. Section 2 provides background material on trends in earnings, enrollment, and aid, and identifies alternative policy motivations for subsidizing the costs of attending college. Section 3 describes the major federal programs available to subsidize higher education costs before, during, and after postsecondary education for individuals.¹ Sections 4 and 5 examine the non-trivial interactions among the various federal programs and compare the ability of different types of aid to deliver benefits. Section 6 discusses how the evolution of aggregate tax and fiscal policy is likely to play a key role in determining both the level and nature of resources available for future federal support for higher education. Section 7 offers a brief conclusion.

Note: This report is available in its entirety in the Portable Document Format (PDF).

Acknowledgments

Elaine Maag is a research associate at the Urban Institute. Katie Fitzpatrick is an intern at the Urban Institute. We gratefully acknowledge the contributions and helpful comments of Leonard Burman, William Gale, Peter Orszag and Lois Rice. Each reviewed multiple drafts of this document that resulted in significant improvements. We are also grateful for the financial support of the Lumina Foundation. The views expressed are those of the authors.

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

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