The Impact of College Grant Aid Programs on Borrowing

According to Benjamin Marx and Lesley Turner, the Pell Grant, a federal program that provides grants to low-income undergraduate students, might be having adverse effects on students’ borrowing behaviors. The amount awarded by the Pell Grant depends on a student’s financial need, the costs of attending school, full-time or part-time student status, and whether the student plans to attend school for a full academic year. The federal government calculates the student’s expected family contribution (EFC) by considering the financial and demographic information submitted on the Free Application for Federal Student Aid (FAFSA). Students who have an EFC above $4,617 are not eligible for the grant, and students who have an EFC equal to zero receive the maximum award ($5,775 for the 2015-2016 year).

Taking advantage of the formula’s cutoff threshold for eligibility, Marx and Turner use regression discontinuity to measure the impact of the Pell Grant on the borrowing decisions and educational attainment of college students at The City University of New York (CUNY). CUNY is the third largest university system in enrollment and one of the most diverse student bodies in the country. According to the National Center for Education Statistics, only 41 percent of CUNY students who enrolled in fall 2006 graduated within six years.

By default, admitted CUNY students receive an initial loan amount of $0 in their aid packages. Therefore, students must submit another application to specify how much aid they want to borrow and whether they are willing to take on unsubsidized debt. The authors point out that this default loan amount might be creating fixed costs for borrowing, and possibly decreasing educational attainment. These fixed costs are defined as the psychological cost of deviating from the default option and the transaction cost of applying once again for loan aid. By setting a default loan amount of zero, CUNY is sending a signal to its admitted students encouraging them not to borrow. Thus, students who might need to borrow to finish their college studies end up not doing so, eventually facing hardships that might lead them to abandon school.

The authors use administrative data from the CUNY system, which describe demographic characteristics, EFC, grant aid, loan aid, and measures of educational attainment. They follow a sample of eight cohorts of first-time, first-year students who entered a CUNY institution in the Fall of the 2004-2005 academic year all the way through the end of the 2010-2011 academic year. The sample included only US citizens or permanent residents. It also dropped students who had not completed the FAFSA, or who had an EFC more than $4,000 from the threshold for Pell Grant eligibility.

There are significant differences between Pell Grant-eligible and -ineligible students. Pell Grant-eligible students are more likely to be nonwhite, have lower SAT scores, are less likely to borrow, and are also less likely to have a college-educated parent. Due to these differences, the investigators use the threshold of the EFC formula to measure the Pell Grant’s impact. Students who were not eligible because they were above the threshold, but were still very close to it, were used as the control group. Students who were eligible but who were also close to the threshold were used as the treatment group. By using this method, the authors ensure that the differences between the treatment and control groups are significantly reduced.

The results suggest that an additional dollar of Pell Grant aid induces first-year students to reduce borrowing by approximately $0.43. For the students who would have had to borrow if they had not received the Pell Grant, every dollar they were granted crowded out over $1.80 in loans. In economics, a crowding out effect occurs when a policy set by the government reduces the role or scope of influence of other agents that otherwise would be actively engaged. In this case, the Pell Grant not only decreases borrowing, but it appears to almost replace it. By controlling for other forms of grant aid (state and institutional), the authors show that these results are robust.

While reducing students’ borrowing might seem like a positive outcome, the authors point out that borrowing should not be entirely replaced by a granting aid program. The psychological costs of setting a default loan amount at zero, a common practice for other college systems, they suggest, are contributing to the Pell Grant’s replacement of debt. Furthermore, the results show that the Pell Grant has no significant effect on school attainment. However, since the authors focused on the observations that were close to the threshold eligibility criteria, this effect might be underestimated. Still, their contribution raises valid questions about the distortions that granting aid programs might be having on students’ behaviors, questions that further studies need to explore more thoroughly.

Article Source: Marx, Benjamin M., and Lesley J. Turner. “Borrowing Trouble? Student Loans, the Cost of Borrowing, and Implications for the Effectiveness of Need-Based Grant Aid.” National Bureau of Economic Research, 2015.

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