The College Board www.com 45 Columbus Avenue New York, New York 10023-6992 040371235 A Primer on Economics for Financial Aid Professionals Sandy Baum ������������� ���������� ���������� � ����������������� �������������� �������� ��������������� A Primer on Economics for Financial Aid Professionals Sandy Baum College Entrance Examination Board New York, 2004 The College Board: Connecting Students to College Success The College Board is a not-for-profit membership association whose mission is to connect students to college success and opportunity. Founded in 1900, the association is composed of more than 4,500 schools, colleges, universities, and other educational organizations. Each year, the College Board serves over three million students and their parents, 23,000 high schools, and 3,500 colleges through major programs and services in college admissions, guidance, assessment, financial aid, enrollment, and teaching and learning. Among its best-known programs are the SAT®, the PSAT/NMSQT®, and the Advanced Placement Program® (AP®).
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Table of Contents INTRODUCTION .1 PART I: BASIC ECONOMIC CONCEPTS .7 Horizontal and Vertical Equity .22 Price Discrimination: Different Prices for Different Students .25 Opportunity Cost: What Are the Trade-Offs? .28 Costs and Revenues: Total, Average, and Marginal .29 Market Structure: Competition Versus Monopoly Power .36 Externalities: The Spillover of Benefits.40 Consumption Versus Investment Goods .43 Models of the Firm and Higher Education Institutions .44 PART II: NEED ANALYSIS METHODOLOGY .49 Defining Necessities .51 Snapshot Versus Long-Term Financial Capacity.53 Defining Living Standards.56 Treatment of Multiple Children in College .58 Defining Income .60 Whose Income Is Relevant? .62 Allowances Against Income .65 Income Protection Allowances.68 Annual Education Savings Allowance and Other Allowances Against Income .68 Defining Assets .70 Whose Assets Are Relevant? .74 The Tax on Savings .79 College Savings Accounts and Prepaid Tuition Plans .81 Allowances Against Assets .83 Asset Protection Allowance .83 Other IM Allowances Against Assets: Cumulative Educational Savings Allowance, Emergency Reserve Allowance, and Low Income Asset Allowance .85 Assessing Income and Assets .87 Marginal Assessment Rates .97 vi A Primer on Economics for Financial Aid Professionals Introduction The fiftieth anniversary of the College Scholarship Service® (CSS®) is an appropriate time to issue the revised edition of A Primer on Economics for Financial Aid Professionals. Originally published jointly in 1996 by the College Board and the National Association of Student Financial Aid Administrators (NASFAA), the Primer is intended to help familiarize those new to financial aid with the fundamental concepts underlying the system and to enrich the understanding and critical perspectives of more seasoned professionals. These same goals have motivated much of the work of CSS over the last half-century. For 50 years, the College Scholarship Service of the College Board has been devoted to improving the need analysis system underlying aid allocation and to supporting financial aid professionals as they endeavor to help students and families meet the challenge of financing a college education.
The price of college, affordability, and the financial aid system are increasingly in the public eye as students and families struggle 1 with rising tuition levels. In today’s environment, need-based aid frequently competes for dollars with grants awarded on the basis of academic quality and other factors, and measures of need are too often manipulated in the interest of other institutional goals. These circumstances make it more and more important that financial aid professionals be in a position to make reasoned and informed decisions about the allocation of student aid dollars and to explain and support their methods. This Primer approaches financial aid from a perspective that is too often ignored.
Written by an economist who has studied financial aid in depth, it asks aid professionals to think more broadly than they otherwise might about both the logic underlying the allocation of student aid and the potential impact of the aid system on the behavior of students and families. Although the financial aid profession has long recognized that sound economic principles should underlie aid allocation formulas, many aid professionals are unfamiliar with and/or intimidated by basic economics. This Primer is an attempt to make economic concepts and their potential application to need analysis more accessible to financial aid professionals. While too many people working in aid offices don’t have adequate time to provide an in-depth answer to the question of the appropriate amount of funding for a particular student, for many others, professional judgment about individual cases is a major part of the job.
In addition, as individual institutions search for creative ways to make their limited aid dollars go further, both in terms of providing educational opportunity and in terms of enrollment management goals, financial aid professionals will become increasingly involved in an individualized process of allocating aid funds. An understanding of the underlying economic principles will inform and facilitate this process. The Primer links economic theory to need analysis in two distinct ways. Part I presents basic economic concepts and discusses their application to college enrollment and student aid.
The concepts included have particular significance for understanding either college pricing systems or the ability and/or 2 A Primer on Economics for Financial Aid Professionals willingness to pay for higher education. For example, everyone reading this Primer is aware that on campuses around the country, there is ongoing debate about whether net price differentials should be based on ability to pay (need), on merit, or on willingness to pay. What is less familiar to many people engaged in this debate is the standard economic concept of price discrimination. Higher education is not unique in selling the same product to different consumers at different prices.
An understanding of the conditions required for price discrimination (the technical name for this practice) and of the implications of this pricing policy in general, can provide useful background for higher education professionals grappling with college pricing and financial aid policy decisions, and strengthen the arguments of those committed to the equitable and efficient allocation of student aid. Some more general economic concepts can also provide a valuable framework for analyzing financial aid. The concept of opportunity cost, for example, is one that even students who are not drawn into the economic mode of reasoning find staying with them as a useful way of thinking about daily life. Opportunity cost refers to the idea that any choice we make involves a sacrifice, a foregone opportunity.
The cost of attending college is not just the tuition, but also includes the wages foregone by students who choose to postpone entry into the labor market. Ignoring this part of the cost of higher education significantly distorts both our understanding of costs and our ability to advise students responsibly about their choices. Part II of the Primer analyzes specific components of the need analysis system from an economic perspective, examining both the underlying assumptions of the system and some specific components of Federal Methodology (FM) and the College Board’s Institutional Methodology (IM). Federal Methodology, legislated by Congress during the 1992 Reauthorization of the Higher Education Act, is the mandated allocation formula for federal student aid.
It represents the second iteration of the congressional attempt to legislate a need analysis system, the Congressional Methodology (CM) having been in effect from 1988 through 1992. Before 1988, colleges and universities were 3 allowed to distribute aid based on the methodology of their choice, commonly the Uniform Methodology (UM) developed by the member institutions of the College Board and American College Testing (ACT), in cooperation with the U. Department of Education, emerging through the Keppel Task Force and maintained by the National Coalition for Coordination of Student Financial Aid. FM still contains many of the details that were part of UM, but has evolved into a complex but imprecise system for allocating funds, rather than a reliable index of financial capacity.
For example, FM does not consider assets for most families with incomes below $50,000 and ignores both home equity and family farm values for all aid applicants. Institutions are obligated to rely on FM to distribute federal funds. But colleges and universities that have significant institutional funds to distribute seek more reliable measures to rank families and students by levels of financial strength. For those institutions, the College Board’s Institutional Methodology (IM) and modifications of that formula are most prevalent.
This methodology resembles the earlier UM and CM, considering home equity, family farms, and other assets for all families and incorporating a minimum contribution for all students. It has been modified in a variety of ways in recent years, as CSS has sought to update and improve the system. Although the second part of this Primer analyzes a number of specific components of both FM and IM, instead of going through any particular formula step by step, the discussion focuses on the requisite framework for any need analysis system. That is, income and assets must be defined, then the methodology must determine which components of income and assets should be assessed to determine expected contributions, as well as what the appropriate assessment rates are.
In addition to addressing general principles of need analysis methodology, the discussion calls attention to ways in which FM and IM differ from each other, to widely recognized shortcomings in the standard formulas, and to some of the proposals currently being discussed within the aid profession that might improve the need analysis system. Readers of this Primer may find it useful to keep some basic principles of public policy analysis in mind. Economists tend 4 A Primer on Economics for Financial Aid Professionals to evaluate public policy in terms of the two criteria of equity and efficiency. The question of whether or not a policy is fair is obviously subjective, but an understanding of who is helped and who is hurt is fundamental to making such a judgment.
Determining whether policies make the most productive possible use of limited resources is also complicated but can be facilitated by a thorough understanding of some basic economic ideas. At times there is a trade-off between equity and efficiency, but the two may also be complementary. Even in the case of need analysis, primarily designed for reasons of equity, paying attention to the incentive effects, the behavioral responses, and the impact of a policy on market outcomes is vital. In rough terms, if we waste a lot of money trying to help people in ways that end up being counterproductive, we will find ourselves with lower levels of overall resources, unable to attain our most basic goals.
If the need analysis system punishes people for certain choices or behaviors—such as saving—those behaviors will be discouraged and we will end up with fewer dollars to distribute to those most in need. If we use limited resources to influence institutional choice among students who would attend college—or enroll in a similar institution—regardless of subsidies, we will have insufficient funds to increase college access and enrollment. In other words, the efficiency aspects of the need analysis system cannot be ignored. Both the equity and the efficiency of the aid system are diminished by its complexity.
Students who do not understand the system and have no way of predicting what aid will be available to them may fail to apply for aid—or fail to apply to college at all. This reality clearly reduces the effectiveness of the aid system in removing financial barriers to college access. This Primer will not answer all the questions of its readers, nor will it reveal the secret to the perfect need analysis system.