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The Insurance Value of Financial Aid

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  • Kristy Fan
  • Tyler J. Fisher
  • Andrew A. Samwick

Abstract

Financial aid programs enable students from families with fewer financial resources to pay less to attend college than other students from families with greater financial resources. When income is uncertain, a means-tested financial aid formula that requires more of an Expected Family Contribution (EFC) when income and assets are high and less of an EFC when income and assets are low provides insurance against that uncertainty. Using a stochastic, life-cycle model of consumption and labor supply, we show that the insurance value of financial aid is substantial. Across a range of parameterizations, we calculate that financial aid would have to increase by enough to reduce the net cost of attendance by 30 to 80 percent to compensate families for the loss of the income- and asset-contingent elements of the current formula. This compensating variation is net of the negative welfare consequences of the disincentives to work and save inherent in the means-testing of financial aid. Replacing just the "financial aid tax" on assets with a lump sum would also reduce welfare.

Suggested Citation

  • Kristy Fan & Tyler J. Fisher & Andrew A. Samwick, 2021. "The Insurance Value of Financial Aid," NBER Working Papers 28669, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:28669
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    Cited by:

    1. Matsuda, Kazushige & Mazur, Karol, 2022. "College education and income contingent loans in equilibrium," Journal of Monetary Economics, Elsevier, vol. 132(C), pages 100-117.

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    More about this item

    JEL classification:

    • D15 - Microeconomics - - Household Behavior - - - Intertemporal Household Choice; Life Cycle Models and Saving
    • G52 - Financial Economics - - Household Finance - - - Insurance
    • I22 - Health, Education, and Welfare - - Education - - - Educational Finance; Financial Aid

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