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National CrossTalk Fall 1999
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Hope for Whom?
Financial aid for the middle class and its impact on college attendance

By Susan Dynarski

FEDERAL AND STATE GOVERNMENTS recently have ushered in a slew of student aid policies aimed at youth from middle- and high-income families. The largest of these new programs are the federal tax incentives known as the Hope Scholarship and Lifetime Learning Credit, which allow families of college students to offset their educational costs with tax benefits of up to $1,500 a year. A second federal initiative, the Education IRA, allows families to put after-tax dollars into college savings and accumulate interest tax-free.

The federal programs join a wide array of aid programs introduced by the states. State-funded merit-based scholarships are the latest student aid fashion to sweep across the states, with more than a dozen legislatures considering such programs. Georgia’s HOPE (Helping Outstanding Pupils Educationally) Scholarship, the inspiration for the federal program, is the largest and best known of the state merit scholarships.

All of these new state and federal programs differ from traditional student aid in one crucial aspect: They are not need-based. Historically, government aid for college has been strongly focused on low-income students. Eligibility for the two largest federal aid programs, the Pell Grant and Stafford Loan, is determined by a complex formula that defines financial need on the basis of income, assets and family size. The formula is quite progressive: Ninety percent of dependent students who receive federal grants grew up in families with annual incomes less than $40,000.

By contrast, the new aid programs are aimed squarely at middle- and high-income families. Tax-deferred savings plans most benefit upper-income families, who face the highest marginal tax rates and have the highest savings rate.

The federal Hope Scholarship and Lifetime Learning Credit have three key characteristics that limit their benefit to low-income families. First, the income cutoffs for eligibility for the subsidies are set high enough that less than ten percent of filing households exceeds them. Second, allowable educational expenses are offset by any need-based aid received. As a result, a student who attends the typical two-year college and is poor enough to receive the maximum Pell Grant receives no Hope Scholarship. Third, the subsidy takes the form of a non-refundable tax credit, so that a family too poor to pay taxes receives no Hope Scholarship.

How will this new breed of student aid affect college attendance rates? There is scant research concerning the impact of tuition subsidies on middle- and upper-income youth, for the simple reason that most existing aid programs focus on needy students. History has therefore provided few experiments that would allow us to measure the responsiveness to aid of middle- and upper-income youth.

There are reasons to suspect that low- and upper-income youth respond differently to aid: Wealth, parental education and academic preparedness are all tightly correlated with income, and each has its own impact on the decision to attend college.

Georgia’s HOPE Scholarship

In this article, the impact of aid on the college attendance of middle- and upper-income students is estimated by evaluating the Georgia HOPE Scholarship. In 1993, Georgia initiated HOPE, which is funded by a state lottery. The program allows free attendance at Georgia’s public colleges for state residents with at least a 3.0 grade point average in high school. Since the first lottery tickets were sold, more than $3 billion in lottery revenue has flowed into Georgia’s educational institutions.

HOPE pays for tuition and required fees at Georgia’s public colleges and universities. Those attending private colleges are eligible for an annual grant, which was $500 in 1993 and had increased to $3,000 by 1996. A $500 education voucher is available to those who complete a General Education Diploma (GED). Public college students must maintain a grade point average of 3.0 to keep the scholarship; a similar requirement was introduced for private school students in 1996.

Georgia education officials, concerned that students would forgo applying for federal aid once the HOPE Scholarship was available, created an application process designed to prevent this outcome. Those from families with adjusted gross incomes lower than $50,000 must complete the Free Application for Federal Student Aid (FAFSA) in order to apply for HOPE. The four-page FAFSA requests detailed income, expense, asset and tax data from the family. Those with family incomes above $50,000 fill out a short, one-page form that requires no information about finances other than a confirmation that family income is indeed above the cutoff.

Despite the widespread attention paid Georgia’s HOPE Scholarship— Georgia politicians have deemed it a great success, and more than a dozen states are weighing the introduction of similar programs—there has been no rigorous evaluation of its impact upon college attendance. Do such programs actually increase college enrollment, or do they simply transfer funds to families who would have sent their children to college anyway?

Georgia’s program likely has increased college attendance rates among all 18- to 19-year-olds by 7.0 to 7.9 percentage points. However, the increase is concentrated among Georgia’s white students, who have experienced a 12.3 percentage point rise in their enrollment rate relative to whites in nearby states. The black enrollment rate in Georgia appears unaffected by HOPE. The differential impact of HOPE on blacks and whites is likely due to the focus of HOPE on middle- and upper-income students who perform well in high school.

Research results suggest that for each $1,000 of subsidy the college attendance rate of middle- and upper-income youth rises by four to six percentage points. This is a surprisingly large response: The estimate is of the same order of magnitude as those reported by studies that examine the effect of aid on low-income students.

Further, the results suggest that about 80 percent of HOPE funds flow to those who would have gone to college in the absence of the subsidy.

For a number of reasons, caution should be used in extrapolating these results to other states and programs. Georgia had attendance rates well below the national average before HOPE was introduced, and it is possible that a similar program in a high-attendance state such as Massachusetts would not have a similar impact. Further, Georgia’s program is unusual in its simplicity, scale and publicity. A less transparent form of subsidy such as a tax credit or tax-free interest on college savings—may not produce responses of similar magnitude.

A federal Hope Scholarship

How confidently can we extrapolate estimates based on the Georgia HOPE Scholarship to programs such as the federal Hope Scholarship?

There are key similarities between the Georgia and federal programs. They are of roughly equal financial value and focus their subsidies on roughly the same portion of the income distribution. The average value of the Georgia HOPE Scholarship for those attending a public college or university is $1,900, while the maximum federal Hope Scholarship is $1,500 and the maximum Lifetime Learning Credit is $1,000.

Both programs have largely excluded low-income students by linking the subsidy to how much outside aid is received (though recent legislation in Georgia will allow low-income students to receive more HOPE funds than they have in the past). Further, neither program excludes the well-off.

The Georgia program has no income cap on participation, while the federal income caps are set quite high in the income distribution.

Despite these similarities, key institutional differences between the Georgia and federal subsidies imply that the impact of the federal Hope Scholarship will be substantially smaller than that of the Georgia program.

The federal program is complicated, and imposes a relatively large burden of paperwork on applicants and schools. The subsidy is delivered through the federal tax code—not known for its transparency or simple paperwork. And the size of the subsidy is uncertain when the college attendance decision is made, since taxpayers do not know the size of their credit until their tax liability and eligible educational expenses for a given year have been determined.

The program is costly to schools, as well, which are required to collect information about who is responsible for a given student’s tuition (parents and outside scholarship providers, for example), and mail to the Internal Revenue Service a listing of the responsible parties, their taxpayer identification numbers, and an annual accounting of the portion of tuition and fees eligible for the tax credit.

By contrast, Georgia’s program has unusually low transaction costs, and the paperwork is minimal, at least for students from families with incomes above $50,000. The four page form that lower-income students fill out is roughly as involved as the typical tax return. In order to ease this process, Georgia college officials assist applicants in completing this form, check it for accuracy, and mail it in.

Tuition effects of the Georgia and federal programs

Opponents of the federal tax credits have expressed concern that they will drive up tuition prices, as schools seek to capture the subsidy. The California legislature has discussed raising tuitions so that its students can qualify for the full federal Hope Scholarship.

Has HOPE driven up tuition prices in Georgia? Public college costs were relatively flat in Georgia before HOPE, with costs in 1993–94 only about six percent higher than their level in 1986–87. Real prices in Georgia actually dropped during the years immediately preceding HOPE. By contrast, public schooling costs in the United States rose steadily between 1986–87 and 1993–94, for a total increase over this period of around 15 percentage points.

After HOPE was introduced, the situation was reversed, with public college costs in Georgia rising at a rate higher than that of the rest of the country. Between 1993–94 and 1997–98, schooling costs rose about 21 percent in Georgia and eight percent in the rest of the United States. Private schooling costs rose slightly faster in the United States than in Georgia before HOPE, but the situation was reversed after HOPE was introduced.

These results suggest that HOPE has had an inflationary effect on college costs in Georgia, especially in the public schools. The inflationary effect of the federal tax credit on tuition is likely to be even stronger. In Georgia, the state government both distributes the subsidy and sets tuition prices for the public sector, which should at least moderate schools’ tendency to raise prices in order to capture the subsidy. Since there is no such brake in the federal program, one would expect the inflationary effects of the federal scholarship to be more severe.

Georgia’s subsidy requires a 3.0 grade point average in both high school and college; the federal program has no grade requirement. While the high school grade point average requirement could magnify HOPE’s effect by encouraging students to increase their academic effort, it also might encourage grade inflation.

Georgia’s college grade point average requirement cuts off financial assistance to students who could make it through college, albeit with mediocre grades, and is therefore almost certain to reduce HOPE’s impact on college attendance. Sixty-four percent of freshmen who received HOPE during academic year 1997–98 lost their scholarships the following year. The college grade point average requirement therefore culls from HOPE eligibility not just those who can’t handle college, but the median college student.

Further, this requirement appears to hit blacks harder than whites. Blacks at the University of Georgia are twice as likely as whites to lose their scholarship after the freshman year. A recent study found that at the Georgia Institute of Technology blacks were substantially more likely than whites to lose their scholarships, though this differential disappeared after accounting for differences in ability as measured by SAT scores.

The substantial rate of attrition from HOPE may explain why its effect on college attendance appears to have dropped in recent years. It is possible that young people on the margin of college attendance have observed the very high rate at which their older peers have lost their HOPE Scholarships, and have decided that the expectation of one year of free tuition is not enough to make college worthwhile.

Another key difference between the Georgia and federal subsidy programs has to do with the conditions into which these two programs have been introduced. The college attendance rate in Georgia when HOPE was introduced was much lower than that in the rest of the United States. It is likely that the effect of the federal Hope Scholarship will vary geographically, producing a larger impact in states where attendance is low and a smaller impact where attendance is high.

Predicting the net impact of the federal Hope Scholarship

Most of the differences between the two programs combine to reduce the effect of the federal program relative to that of Georgia’s. The likelihood, therefore, is that the federal Hope Scholarship will have a lesser impact on college attendance.

Further, the Georgia experience indicates that any impact of the federal Hope Scholarship on college attendance will come with the price of exacerbating already substantial racial and income gaps in college attendance. In Georgia, the HOPE Scholarship has increased overall college attendance but has widened the gap in attendance rates between whites and blacks and between rich and poor.

Nationwide, the gap in attendance rates between recent high school graduates in the bottom and top quartiles of the family income distribution is 30 percentage points. Further, differences in college attendance across income groups have been growing over time. Programs that primarily subsidize the college attendance of middle- and upper-income youth, like the federal Hope Scholarship and Georgia HOPE Scholarship, will only exacerbate this trend.

The federal Hope Scholarship, which focuses on the same slice of the family income distribution as Georgia’s program, is likely to increase already large racial and income gaps in college attendance in the United States.

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