Student Financial Aid: Need Determination Could Be Enhanced through Improvements in Education's Estimate of Applicants' State Tax Payments
Published: 2005-01-21T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: In 2003, the Department of Education (Education) proposed an update to the state and other tax allowance, a part of the federal need analysis for student financial aid. Most federal aid as well as some state and institutional aid is awarded based on the student's cost of attendance less the student's and/or family's ability to pay these costs--known as the expected family contribution (EFC). The allowance, which accounts for the amount of state and other taxes paid by students and families, effectively reduces the EFC. Given the potential impact of the allowance on the awarding of aid, we determined what factors have affected the updating of the tax data on which it is based, the effects the proposed 2003 update would have had on financial assistance for aid applicants, any limitations in the method for deriving the allowance, and strategies available to address them.
section_title: What GAO Found
paragraphs: While Education has been required to revise the allowance annually since 1993, prior to 2004 it attempted to update the allowance only twice--in 1993 and again in 2003--but the latter update was suspended. As a result, the 1988 IRS tax data used for the 1993 update remained in effect. The lack of updates is primarily because Education did not annually seek data needed to update the allowance or establish effective internal control to guide the updating process. Also, Education did not consider alternatives when data were not readily available. Had the update been implemented in 2004-2005, the allowance would have decreased for most states; as a result, the EFC would have increased by about $500, on average, for a majority of aid applicants. Of those with an EFC increase, 38 percent would either have received less in Pell Grants ($144 less on average) or would have become ineligible for them; the percentage of recipients affected would have varied by income. Overall Pell Grant expenditures would have decreased by $290 million. Increases in EFCs could also have affected other forms of aid, including state aid; these effects in turn could have affected Stafford loans and Parent Loans for Undergraduate Students. The impact of the proposed update on Campus-Based, state, and institutional need-based aid would likely have varied based on state and institutional aid awarding policies and changes in state allowances. Due to certain limitations of the IRS dataset with respect to calculating the allowance, and problems with how Education uses this dataset, the current allowance may not reflect the amount of taxes paid by students and families. The dataset is limited because the taxpayers included in it are generally not representative of aid applicants, it does not include all state and other taxes paid by students and families, and the tax data are several years older than the income information reported by applicants on aid applications. In addition to these limitations, Education does not make full use of the dataset to better reflect the varying tax rates paid by taxpayers in different income groups. Strategies we identified for addressing the limitations of the tax allowance include (1) using IRS data with revisions to the method for calculating the allowance, (2) substituting IRS data with one of several alternative data sources, (3) using a standard allowance for all aid applicants irrespective of state of residence, or (4) collecting tax information directly from aid applicants. These could require modest to substantial changes, would differ in their impact on applicants and federal costs, and could require legislative changes

section_title: Letter
paragraphs: In 2003–2004, an estimated $98 billion in financial aid was awarded to  students for postsecondary education through the Title IV federal student  aid programs, as well as state and institutional grant programs. Title IV aid  is currently awarded based on a formula specified in the Higher Education  Act (HEA); many states and postsecondary institutions also use this  formula to award their own student aid. A substantial portion of this aid is  awarded based on the difference between a student’s cost of attendance  and an estimate of the student’s and/or family’s ability to pay these costs— called the expected family contribution (EFC)—determined by this  formula. To apply for Title IV aid, students submit a Free Application for  Federal Student Aid (FAFSA) on which they report their own and/or their  families’ income, assets, and federal income tax expenses. State and other  tax expenses, on the other hand, are not collected on the FAFSA form.  Rather, Education uses a rate specified in law, subject to revision by  Education—called the state and other tax allowance—to estimate such  taxes.
Congress incorporated the state and other tax allowance as a part of the  formula by including in the Higher Education Act a series of tables listing  the applicable allowance for students and families by state. The tables list  specific percentage values, or rates, that are used to exclude a portion of  students’ and families’ incomes in determining their EFC. Thus, under the  formula, the state and other tax allowance effectively reduces the EFC for  students and families. The allowances were originally developed based on  information compiled by the Department of Treasury’s Internal Revenue  Service’s (IRS)–Statistics of Income (SOI) Division, specifically state and  other taxes paid by taxpayers and reported on their federal income tax  returns.
While the Department of Education (Education) is required by law to  update the state and other tax allowance, its proposal to do so in 2003 was  met with substantial concern because it was the first update in a number  of years and because the update would likely affect the EFC for students  and families and the amount of student aid received. In view of the  uncertainty and controversy that followed Education’s proposed update  and Congress’ decision to suspend the update for 1 year, you asked us to  shed light on issues associated with the tax allowance question and the  department’s proposed 2003 update. This report examines (1) what tax  data form the basis of the current tax allowance and what factors have  affected regular updates, (2) the effect Education’s proposed 2003 update  would have had in award year 2004–2005 on financial assistance for  students and families, (3) the extent to which current methods for  determining the allowance accurately measure how much students and  families have paid in state and other taxes, and (4) the strategies available  to address any problems in deriving the allowance.
To do our work, we reviewed federal laws governing how Education is to  update the state and other tax allowance and examined documents  pertaining to this process. We used Education’s aid applicant sample file  from the 2002–2003 award year to estimate changes to the expected family  contribution and Pell Grant awards nationally that would have resulted  from Education’s proposed update. We analyzed Education’s Cost  Estimation and Analysis Division’s Statistical Abstract (CEAD STAB) data  to estimate the proportion of financial aid recipients who could have  experienced a change in their federal loans as a result of the proposed  update. We assessed the reliability of the aid applicant and CEAD STAB  data and determined that they were sufficiently reliable for our review. To  obtain estimates on changes in state-provided need-based aid programs,  we contacted two states, one with a likely high level of impact (Wisconsin)  and the other with a likely low level of impact (Tennessee). To illustrate  changes in students’ receipt of Title IV aid and need-based aid provided by  schools, we relied on estimates from four schools—two public institutions  (University of Wisconsin-Madison and Middle Tennessee State University)  and two private nonprofit institutions (Marian College of Fond du Lac and  Carson-Newman College). To develop strategies to address the  allowance’s limitations in measuring students’ and parents’ state and other  tax payments, we identified and analyzed alternative data sources that  have state and local tax information. Finally, to gain further perspective on  our objectives, we interviewed officials from the Advisory Committee on  Student Financial Assistance (ACSFA) and other federal officials, along  with state, school, and national association officials as well as other  student financial aid experts.
We conducted our review from October 2003 through November 2004 in  accordance with generally accepted government auditing standards. For a  more detailed explanation of our methodology, see appendix I.
subsections: section_title: Background
paragraphs: The Higher Education Act specifies a formula, known as the federal need  analysis methodology, that is used to determine students' eligibility for  federal student aid. A variety of federal grants and loans are available to  assist students pay postsecondary expenses. While some federal aid is  allocated based on a student’s need for financial aid that is determined by  the formula, other federal aid is allocated regardless of need. Many states  and institutions have their own student aid programs, providing students  an additional source of aid to help pay for postsecondary expenses.
subsections: section_title: Federal Need Analysis Methodology
paragraphs: The federal need analysis methodology is used to determine a student’s  need for financial aid by comparing a student’s and/or family’s expected  family contribution to the student’s cost of attendance (COA). The EFC is  defined as the household financial resources that are considered available  to help pay for the student’s postsecondary education expenses and is  calculated by reducing the household financial resources reported by aid  applicants on the Free Application for Federal Student Aid by certain  expenses and allowances, including a state and other tax allowance. A  student is classified as either financially dependent on his or her parents  or independent in the financial aid process. This classification is important  because it affects the factors used to determine a student’s EFC. For  dependent students, the EFC is based on both the students and parents’  income and assets, as well as whether the family has other children  enrolled in college. For independent students, the EFC is based on the  student’s and, if married, spouse’s income and assets and whether the  student has any dependents other than a spouse, and the number of family  members enrolled in college.
To capture and reflect changes in students’ and families’ state and other  tax liabilities, Education is responsible for annually updating the state and  other tax allowance tables that were established in the HEA. Education  determines the state and other tax allowance based on state and local tax  information from federal tax returns filed with the Internal Revenue  Service and compiled by its Statistics of Income Division. For dependent  students and independent students without children, the allowance is  composed of state and local income taxes. For parents of dependent  students and independent students with children, personal property taxes  and real estate taxes are added to the allowance.
The costs of attending a postsecondary institution that a student faces  include tuition, fees, books, and living expenses. The student may be able  to receive financial aid to help cover costs of attendance depending on  where the student wants to enroll as well as the student’s and family’s  financial resources. If the price of attendance is greater than the expected  family contribution, the difference between the two represents the  student’s financial need. If the EFC is greater than the price of attendance,  the student is not eligible for federal need-based aid but may still qualify  for aid that is not based on need. (See fig. 1.)
Postsecondary institutions are responsible for determining individual  student’s eligibility for specific sources of financial aid and compiling  these sources to meet each student’s need—a process known as  packaging. Part of this process involves deciding which types or sources  of aid should be awarded first—for example, grants or loans, federal or  nonfederal aid, need-based or non-need-based aid. In awarding aid,  institutions typically first package any grants for which the student is  eligible and then offer loans. Another factor considered in packaging aid is  whether to reduce aid from any source in a student’s package to offset an  aid award from another source.
section_title: Federal Aid Provided under Title IV of the Higher Education Act
paragraphs: Title IV of the HEA, as amended, authorizes the following federal aid  programs:    Pell Grants—Pell Grants are grants to low- and middle-income  undergraduate students who have federally defined financial need and  who are enrolled in a degree or certificate program. In general, a student’s  Pell Grant award is determined by subtracting a student and family’s EFC  from either the maximum allowable Pell Grant award, currently $4,050, or  the COA, whichever is less.
Stafford and PLUS Loans—These loans may be made by private lenders  and guaranteed by the federal government (guaranteed loans) or made  directly by the federal government through a student’s school (direct  loans).
Subsidized Stafford Loans—Subsidized loans are made to students  enrolled at least half-time in an eligible program of study that have  federally defined financial need. The federal government pays the  interest costs on the loan while the student is in school. Subsidized  loans are subject to certain maximum loan limits and are awarded  based on the difference between a student’s COA less EFC and other  awards of student aid including Pell Grants, state or institutional  grants, etc.  A change in a student’s EFC may—or may not—affect the  amount of a subsidized loan award depending on its effect on other  components of the student’s financial aid package.
Unsubsidized Stafford Loans—Unsubsidized Stafford loans are non- need-based loans made to students enrolled at least half-time in an  eligible program of study. Although the terms and conditions of the  loan (e.g., interest rates) are the same as those for subsidized loans,  students are responsible for paying all interest costs on the loan. While  Stafford unsubsidized loans are not need-based aid, a change in a  student’s or family’s EFC may nonetheless affect the amount a student  may borrow. Unsubsidized loans are awarded based on the difference  between a student’s COA less other awards of student aid—including  Pell Grants, state and institutional grants, and subsidized loans. These  loans are subject to the combined maximum loan limits for subsidized  and unsubsidized loan awards. A change in a student’s EFC that affects  Pell Grant, subsidized loan, or state or institutional grant awards may  therefore affect the amount of an unsubsidized loan award.
PLUS Loans—PLUS loans are non-need-based loans made to  creditworthy parents of dependent undergraduate students enrolled at  least half-time in an eligible program of study. Borrowers are  responsible for paying all interest on the loan. Like unsubsidized loans,  PLUS loans are generally awarded based on the difference between a  student’s COA less other awards of student aid including unsubsidized  loan awards. As is the case with unsubsidized loans, a change in a  student’s or family’s EFC can affect the amount of a PLUS loan that a  parent may borrow.
Dependent students may borrow combined subsidized and unsubsidized  Stafford loans up to $2,625 in their first year of college, $3,500 in their  second year, and $5,500 in their third year and beyond. Independent  students and dependent students without access to PLUS loans can  borrow combined subsidized and unsubsidized Stafford loans up to $6,625  in their first year, $7,500 in their second year, and $10,500 in their third  year and beyond. There are aggregate limits for an entire undergraduate  education of $23,000 for dependent students and $46,000 for independent  students and dependent students without access to PLUS loans.
Campus-Based Aid—Participating institutions receive separate  allocations for three programs from Education.  Funds are distributed to  institutions in part on the basis of the institution’s previous allocation  levels and in part on the basis of the aggregate financial need of eligible  students in attendance.  The institutions then award the following aid to  students:   Supplemental Educational Opportunity Grants (SEOG)—SEOG  grants are grants for undergraduate students with federally defined  financial need. Priority for this aid is given to Pell Grant recipients. In  general, an annual SEOG award may not be less than $100 and may not  exceed $4,000.
Perkins Loans—Perkins loans are low-interest (5 percent) loans to  undergraduate and graduate students. Interest does not accrue while  the students are enrolled at least half-time in an eligible program.  Priority is given to students who have exceptional federally defined  financial need. Students can borrow up to $4,000 for any year of  undergraduate education with an aggregate limit of $20,000.
Work-Study—Work-Study is employment in on- or off-campus jobs for  which students who have federally defined need earn at least the  current federal minimum wage. The institution or off-campus employer  pays a portion of their wages, while the federal government pays the  remainder. Work-study is awarded based on the difference between a  student’s need less other aid awarded.
section_title: Students Received about $98 Billion in Federal, State and Institutional Aid in 2003–2004.
paragraphs: Students received an estimated $98 billion in financial aid in award year  2003–2004 from the Title IV federal aid programs as well as state and  institutional grants, of which the federal government provided more than  two-thirds. Federal assistance is composed of both loans and grants, and  most federal grant aid is need-based. States distributed about $6 billion in  student aid. Institutions provided about $23 billion in the forms of need- based grant and merit-based aid. (See fig. 2.)
section_title: The Current Tax Allowance Is Based on 1988 Data Due In Part to Education’s Limited Efforts in Updating the Allowance
paragraphs: The current state and other tax allowance is based on 1988 tax data due in  part to Education’s limited efforts in updating the allowance. While  Education has been required to revise the allowance tables annually since  1993, prior to 2004 it had attempted to update the allowance twice—once  in 1993 and once in 2003—but the latter update was suspended. As a  result, the 1988 tax data used for the 1993 update are still in effect. The  lack of updates is primarily because Education did not annually seek data  needed to update the allowance and did not establish effective internal  control to guide the updating process. In addition, Education did not  consider alternatives when data were not readily available.
subsections: section_title: The Current Tax Allowance Is Based on 1988 Tax Data
paragraphs: While Education has published the allowance tables used to award Title IV  aid in the Federal Register annually since 1993, prior to 2003 these tables  had been based on 1988 tax return information compiled by SOI. Congress  incorporated the state and other tax allowance into the HEA in 1986 on the  basis of 1983 SOI data but did not establish a mechanism to update the  basis of the allowance until 1992. Amending the Higher Education Act in  that year, Congress directed Education to “publish in the Federal  Register…revised table of State and other tax allowances” annually, and  to “develop such revised table after review of the Department of the  Treasury’s Statistics of Income file and determination of the percentage of  income that each State’s taxes represent” for those residents. Education  published the first updated tables of the allowance in 1993 after reviewing  SOI’s 1988 tax data, the most recent data available at that time. Tables 1  and 2 present these revised tax allowances, by dependency status and  state.
Although Education has published allowance tables annually since 1993,  the published allowances continued to be based on 1988 SOI data until  2003, when new tables based on 2000 SOI tax data were published.  Education intended to use the new tables to award student aid in 2004– 2005 but did not do so in light of legislation that prohibited it from doing  so.  As a result, the state and other tax allowance used to award financial  aid continued to be based on 1988 tax data.
section_title: Education Did Not Annually Seek Data to Update the Allowance, Consider Alternatives when Such Data Were Not Readily Available, or Establish Effective Internal Control to Guide the Updating Process
paragraphs: Prior to 2003, Education’s efforts to update the allowance were limited: It  neither annually sought data to update the allowance nor pursued  alternatives when SOI data it had used previously were not readily  available. According to Education’s records, the department only sought  data to update the allowance for 6 of the 11 years since it was first  directed to annually update the tax allowance. SOI records also document  that Education did not routinely request data. Even when Education did  request data, it is difficult to determine exactly what data were requested  because such requests were not made in writing. Rather, Education’s  documentation consists of informal file notes of telephone contacts with  SOI officials that are minimal and do not describe the substance of what  was discussed. Furthermore, as of the end of our audit work, Education  could not provide us with written procedures guiding staff on the routine  steps necessary to update the tax allowance or to identify what data would  be needed to update the allowance.
After Education published the 1993 update to the allowance, on the basis  of 1988 SOI tax data, Education sporadically sought data from SOI to  develop subsequent updates. According to both Education and SOI  officials, however, SOI would not have provided these data on a cost-free  basis. According to SOI officials, the 1988 tax data was produced to  illustrate the type of information SOI could develop that clients, such as  states, might find useful and be willing to purchase in the future. SOI never  intended to produce the data as a regular series, and the fact that it was  useful for Education’s purposes was coincidental. Education’s records do  not indicate what actions the agency undertook when it first learned that  SOI would not provide data cost-free, including the extent to which it  considered paying for such data. Education officials told us, however, that  they never sought a cost estimate from SOI because they did not wish to  pay for the data. Moreover, Education officials told us that they did not  consider using data other than SOI data because they believed Education  did not have the discretion to do so under the law. Beginning in 2000,  about 1 year after Education last contacted SOI, SOI began to annually  publish on its Web site data that Education could have used to update the  allowance. However, Education was unaware of these data because it did  not contact SOI again until 2003 for the purpose of making its proposed  update that year.
As we have pointed out in numerous reports, weak internal control can be  a contributing factor to, or cause of, insufficient execution of agency  responsibilities. Collectively, internal controls are an integral component  of an organization’s management intended to provide reasonable  assurance that, among other things, operations are effective and efficient.  Education’s failure to fully document its attempts to update the allowance  over the past several years and its lack of written procedures to guide staff  efforts to ensure that they take the steps necessary to update the  allowance, such as a checklist, are indicative of an ineffective system of  internal control. Our Standards for Internal Control in the Federal  Government provides guidance to agencies to help them assess, evaluate,  and implement effective internal controls that can be helpful in improving  their operational processes.
section_title: Education’s Proposed Update Would Have Increased Expected Family Contributions, Thereby Affecting the Allocation of Federal Aid and Potentially State and Institutional Aid as Well
paragraphs: Under the proposed update, the state and other tax allowance would have  decreased for most states; the change in the allowance, in turn, would  have increased the amount that families are expected to contribute by  about $500 on average for a majority of student aid applicants. Of those aid  applicants with an increase in their EFC, some would have received lower  Pell Grant awards or would have become ineligible for Pell Grants.  Increases in EFCs would not only have affected Pell Grants but possibly  other forms of aid, and these effects in turn would have affected Stafford  and PLUS loan awards. The extent to which the proposed update would  have affected federal Campus-Based, state, and institutional aid would  likely have varied according to factors such as aid awarding policies and  changes in a state’s allowance.
subsections: section_title: Under the Proposed Update, Expected Family Contributions Would Have Increased by about $500, on Average, for a Majority of Student Aid Applicants
paragraphs: Education’s tax allowance update would generally have increased the  dollar amount that families would be expected to contribute to a student’s  education, but the percentage of student aid applicants affected would  have varied by state and household income, and the size of the increase  would have varied by state. EFCs would increase by about $500 on  average for those with an increase (from an average of about $9,620 to  about $10,115), but aid applicants from states with larger decreases in  their tax allowance rates would have had a larger increase in their EFCs.  Table 3 shows the proposed changes to the allowance and the estimated  EFC impacts, by state. For example, Delaware would have had a 4  percentage point decrease in its tax allowance for families earning $15,000  or more—from 7 percent to 3 percent—and a 2 percentage point  decrease for individuals, resulting in an EFC increase of $834 on average,  among applicants in Delaware with an increase. In contrast, Nevada would  have had a 1 percentage point decrease in the allowance for families (and  a 1 percentage point increase for individuals), and its residents would have  had an expected contribution increase of $186 on average. Similarly, the  percentage of applicants affected would have varied from state to state. In  Wisconsin, for example, the percentage of student aid applicants affected  would have been slightly over 80 percent, in contrast to Connecticut,  where just under 1 percent of applicants would have been affected. With  regard to household income, over 90 percent of families earning more than  $25,000 would have been expected to contribute more under the update,  while only about 20 percent of families earning $25,000 or less would have  been expected to contribute more. Across all states, we estimate that the  update would have affected more than 60 percent of aid applicants and  would have resulted in an EFC increase of $3.5 billion collectively in  award year 2004–2005.
section_title: If Expected Family Contributions Had Increased, Some Aid Applicants Would Have Received Lower Pell Grant Awards or Become Ineligible for Them
paragraphs: Had Education’s proposed update been adopted, thus raising the expected  family contribution for aid applicants, 38 percent of recipients would have  either seen a decrease in their Pell Grant award or would have become  ineligible for the grant altogether; taken together, the average reduction  among those with a decrease in their amount would have been $144. In  particular, 36 percent of recipients would have seen a decrease of $133 on  average in their Pell Grant award but would have remained eligible for the  awards in award year 2004–2005. Another 92,000 recipients, or 2 percent of  those receiving Pell Grants, would no longer have been eligible and  typically would no longer have received the minimum Pell Grant award of  $400. As a result, the proposed update would have decreased overall  federal Pell Grant expenditures by $290 million. Students residing in states  with larger decreases in their allowances would have faced larger  decreases in Pell Grant amounts and are more likely to have become  ineligible for them. Table 4 shows the average decrease in Pell Grant  awards for those who would have seen a decrease in their Pell Grant  award or who would have become ineligible for them, by state.
Students with relatively higher household incomes would have been more  likely to face a decrease and would have faced substantially greater  decreases in their Pell Grant awards than those with lower household  incomes. On the other hand, the impact of the proposed update would  not seem to have varied much by whether students are financially  independent of their families. Figures 3 and 4 show the proportion of those  facing a decrease in Pell awards and the median amount of such  decreases, by income group.
section_title: Changes in EFCs Could Have Affected Stafford and PLUS Loan Awards
paragraphs: Stafford and PLUS loans could have been affected due to EFC changes as  well. Those applicants for whom a change in EFC would have resulted in a  change in other aid received—including Pell, state, and institutional  grants—would likely have seen a change in their federal loans. This is  because federal loan amounts depend, in part, on the amount of other aid  received. However, even if a change in EFC would not have changed other  aid received, some students may still have seen a change in their  subsidized Stafford loan amount. Among those currently receiving federal  loans, we estimate that over 20 percent of subsidized and unsubsidized  Stafford loan holders and about 85 percent of PLUS loan holders could  have seen a change in their loan amount due to their EFC increase. (See  app. I for an explanation of our estimation methodology.) Figure 5 shows  the proportion of undergraduate Stafford loan recipients who could have  had a change in their subsidized loan amounts, by income and dependency  status. Our case studies of students at selected schools for whom a change  in EFC would have resulted in a change in their federal loans show that as  the EFC would have increased, subsidized loans would have decreased,  and unsubsidized loans would have increased in response to the decreases  in subsidized loans and other forms of financial aid. In addition, PLUS  loans could have made up for these decreases as well.
section_title: The Extent to Which the Proposed Update Would Have Affected the Allocation of Federal Campus-Based, State, and Institutional Need-Based Aid Would Likely Have Varied
paragraphs: While changes in the EFC could have affected Campus-Based awards,  institutions have some discretion in allocating federal Campus-Based aid;  as a result, the effects of the proposed update would have likely varied  across institutions. The effect of the update on state and institutional need- based aid would also have varied based on differences in state and  institutional aid awarding policies and on how much the tax allowance  would have changed for each state.
subsections: section_title: Institutions Have Discretion in Allocating Federal Campus- Based Aid, So the Effects of the Proposed Update Would Likely Have Varied
paragraphs: Our case studies of students at the four selected schools show that even  though the EFC for the majority of students would have changed, Campus- Based awards would tend not to have been affected by the proposed  update. However, some students would have been affected, and the effect  would have varied across schools, due in part to differences in award  policies. Specifically, had the proposed allowance been implemented for  2004–2005, we estimate that less than 15 percent on average of case study  students receiving Supplemental Educational Opportunity Grants and  Work-Study aid would have faced a lower award. The effects would have  varied significantly by school because of differences in schools’ eligibility  criteria for Campus-Based awards and the maximum awards provided. For  example, eligibility for SEOG at one case study school is capped at an EFC  of $3,850, whereas eligibility at another is at an EFC of $2,800, so a student  whose EFC increased from $2,700 to $2,900 would have become ineligible  for an SEOG at one school but not the other. As another example, one  school offers $3,000 in Work-Study, and another limits the amount to  $1,000, thereby demonstrating the different amounts involved. With regard  to Perkins loans, we estimate that about 20 percent of students at the case  study schools on average would have seen a decrease in their loan amount  due to the proposed update. For students who see decreases in their  Perkins loans, the decrease would have been about $1,200 on average but  would have varied significantly by school due to differences in eligibility  criteria. Table 5 shows the case study results of changes in these three  school-administered federal programs.
The majority of states use the federal need analysis methodology to  allocate state need-based aid; as a result, the proposed update could have  affected the amount of and the extent to which students receive state  grants. The effect would have varied by state due to, among other factors,  differences in changes to the tax allowance by state and differences in  state award policies. In Wisconsin, for example, we estimate that over  50 percent of state aid award recipients in our case study would have seen  a decrease in their state award. In contrast, in Tennessee, just over 10  percent of recipients in our case study would have seen a decrease in their  state award. The average reduction for Wisconsin students would have  been less than that for Tennessee students due to the differences in how  the states compute awards: Wisconsin's computation decreases aid for  each dollar increase in EFC by less than Tennessee's computation. (See  table 6.)
As with state aid, the effect of the proposed update on the need-based aid  provided by schools themselves would have varied significantly across  schools due to, among other factors, differences in institutional award  policies and changes in the EFC of students attending the institutions.  However, the impact would be limited to schools that use the federal  methodology to award aid. Since institutional aid may change as a result of  both changes in the EFC and changes in other aid awarded, the effect of  the increased EFC on institutional aid cannot be easily determined. For  example, a school that bases its award solely on EFC might decrease its  award as a result of an EFC increase, while a school that bases  institutional aid on other aid awarded might increase the institutional  award for some students. At the two private nonprofit schools included in  our case studies, our results show that while more than 20 percent of  students at each school would have faced a decrease in institutional need- based aid under the proposed allowance, more than 10 percent of students  at these same schools would have received more institutional aid. Overall,  case study students attending one private nonprofit school would have  seen a decrease in institutional aid of almost $800 on average, whereas  students at the other school would have seen a decrease of over $425 on  average.
section_title: The Current Allowance May Not Capture the Taxes Paid Due to the Type of Data and Methodology in Use
paragraphs: As a result of certain limitations of the SOI dataset for the purpose of  calculating the allowance and problems with how Education uses this  dataset, the current state and other tax allowance may not reflect the  amount of taxes paid by students and families. The dataset is limited for  this purpose because the taxpayers included in it are generally not  representative of financial aid applicants, the tax data it provides do not  include all state and other taxes paid by students and families, and the tax  data are several years older than the income information reported by  students and families on the FAFSA. In addition to the limitations of the  SOI dataset, Education does not make full use of the dataset to account for  the varying tax rates paid by taxpayers in different income groups.
subsections: section_title: The Tax Data Used for the Allowance May Not Represent Those Taxes Paid by Financial Aid Applicants
paragraphs: The tax allowance calculated by Education may not reflect the taxes paid  by most financial aid applicants because it is drawn only from those who  itemize deductions on federal income tax returns—filers who may be  taxed at a different rate than those who do not itemize. Because many  FAFSA applicants have lower income—and taxpayers in lower income  groups tend not to itemize—many applicants may not itemize. Specifically,  we estimate that about 63 percent of FAFSA applicants do not itemize.  Further, itemizers and nonitemizers within the same gross income group  may have different state and other tax rates. On the one hand, for example,  itemizers may be more likely to own a home than nonitemizers and thus  would have a higher state and local tax liability due to real estate taxes.  Conversely, those who itemize on their federal tax return may be more  likely to itemize on their state return—and therefore have larger  deductions, a lower state taxable income, and thus a lower state income  tax than those who do not itemize on their federal return.
section_title: Data Used for the Current Allowance No Longer Include State and Local Sales Taxes
paragraphs: Although sales taxes were included in SOI data when Congress formally  provided for a tax allowance in the 1986 HEA amendments, tax reform  legislation subsequently disallowed the deduction of state and local sales  taxes, effectively eliminating them from this dataset. Therefore, the data  collected by SOI for tax year 1987 and beyond have not reflected all state  and other taxes. Excluding sales taxes may cause the allowance to be  lower than it otherwise would be, especially for students and families who  reside in states where sales taxes compose a significant portion of state  and local revenue. In October 2004, Congress passed and the President  signed the American Jobs Creation Act of 2004, which provides taxpayers  who itemize deductions the choice of claiming a state and local tax  deduction for either sales or income taxes, but only for tax years 2004 and  2005. As a result, the data collected by SOI for tax years 2004 and 2005 will  likely include a mix of sales and income tax deductions reflecting the  choices made by tax filers. Were these data used to update the allowance,  the deductibility of sales taxes could increase the allowance for students  and families, especially for those who reside in states where sales taxes  compose a significant portion of state and local revenue. Regardless, the  SOI data will not reflect both state and local sales and income taxes paid  by individual taxpayers, as was the case prior to tax year 1987.
section_title: SOI Tax Data Are Several Years Older than Reported Income Information
paragraphs: SOI data available for any given award year are several years older than  the income information reported by aid applicants on the FAFSA. For  example, in its proposed update for award year 2004–2005 that was  published in May 2003, Education used 2000 SOI data, the most recent  available at the time of its data request. Because applicants would report  2003 income information for award year 2004–2005, had the allowance  been implemented, there would have been a mismatch of 3 years between  the tax data and the income data. Table 7 shows when SOI publishes the  state and local tax data after the end of a tax year. Some time lag between  the end of a tax year and when SOI publishes data for that year is expected  because returns are collected after the end of the tax year and because of  the time needed for processing those returns. This time lag could be  extended when there are unexpected difficulties in processing the returns.  For example, 2002 tax data were published after about 2 years, while 2000  and 2001 were published in 15 months. Further, SOI officials reported that  the agency may be unable to publish the 2003 tax tables because it has  been experiencing technical problems in processing returns from that  year.
section_title: Education’s Calculation of the Allowance Does Not Fully Consider Varying Tax Levels Paid by Different Income Groups
paragraphs: Education’s method of calculating the state and other tax allowance does  not accurately capture the amount in taxes paid by students and families.  While Education calculates an allowance for each of the two income  categories established by Congress—those earning less than $15,000 and  those earning $15,000 or more—its methodology does not take into  account the varying level of taxes paid by these two groups. To determine  the allowance for families with income less than $15,000, Education uses  the total of state and local taxes paid by all tax itemizers regardless of  income, despite the fact that the SOI data provide separate information for  12 different income groups. Education’s methodology likely  overestimates the taxes paid by the lower-income group for two reasons.  First, higher-income individuals generally face higher tax rates than lower-  income individuals. Our analysis of 2001 SOI tax data shows that those  with an income below $20,000 have a state and other tax liability of about  3 percent on average, while those with an income of $20,000 or more have  an average 5 percent tax liability. (See app. III.) Second, higher-income  individuals are also more highly represented in the SOI data than lower- income individuals. For example, our analysis of the 2001 income  distribution of financial aid applicants and of itemizers shows that about  35 percent of aid applicants have an income of less than $20,000, while less  than 10 percent of itemizers have incomes in that range. (See table 8.)
To calculate the allowance for the higher-income group, Education  deducts a percentage point from the rate it calculates for the lower income  group, a process that fails to account for the fact that higher-income  individuals face higher tax rates than lower-income individuals. Since the  estimate for the lower-income group reflects more of the taxes paid by  those with higher income, this methodology likely underestimates the  taxes paid by this higher-income group.
section_title: Four Strategies Might Address Some of the Limitations Associated with the Tax Allowance and Would Yield a Variety of Effects on Federal Spending and Aid Recipients
paragraphs: We have identified four strategies for addressing the limitations of the tax  allowance that range from modest to more substantial changes to the  process: (1) continue to use SOI data but with a revised method for  calculating the allowance, (2) substitute SOI data with one of several  alternative data sources, (3) use the same allowance for all aid applicants  without regard to state of residence, or (4) collect information directly  from the aid applicants themselves. Except for the first option, use of  these strategies would require legislative changes. Also, these four  strategies differ in their impacts on federal costs and on aid applicants.
subsections: section_title: Use SOI Data with a Revised Methodology
paragraphs: The first strategy would be to make better use of SOI data to calculate the  tax allowance, such as by modifying how the allowance is calculated and  coordinating with SOI to ensure that the most recently available data are  used. Education could use the SOI data on separate income bands to  calculate the allowance for families rather than using the aggregate totals  that SOI publishes. This would ensure that tax rates for different income  bands are based on information more representative of those groups. With  regard to coordinating with SOI, Education obtained SOI data for tax year  2000 for its update in 2003 about 3 months before SOI published data for  tax year 2001. Thus, when Education published its proposed update in  2003, it was not based on the most recently available data. Coordinating  with SOI could reduce the mismatch between the year of the income data  collected from applicants and the tax data collected from SOI from 3 to 2  years. Education officials acknowledged that in the future, they may have  the flexibility to wait for more recently available SOI data and still meet  their schedule for publishing notice of a proposed update to the state and  other tax allowance. Appendix IV shows what the tax allowance would be  under this strategy for each state.
section_title: Replace SOI Data with One of Several Other Datasets
paragraphs: The second strategy would be to discontinue use of SOI tax data and to  replace it with publicly available data, such as the following:    Bureau of Economic Analysis Personal Income and U.S. Census Bureau    Description—The Bureau of Economic Analysis (BEA) annually  publishes “Personal Income” tables, which cover aggregate household  income, by state and are based on data from federal and state  government programs, such as state unemployment insurance  programs. The U.S. Census Bureau annually publishes “State  Government Tax Collections” tables, which include overall state  figures for individual income taxes, real estate taxes levied by states  but not local governments, property taxes, and sales taxes for both  individuals and businesses. This information is gathered by the U.S.  Census Bureau through a mail canvass of appropriate state government  offices that are directly involved with state-administered taxes; locally  collected and retained tax amounts are not included in the survey. Both  sets of tables and related documentation are available via the Internet.
Use—Education could calculate the allowance by combining the  information from both sets of tables. This approach has three potential  advantages over using SOI data: The BEA data includes income from  the entire population, including both filers and nonfilers, and the  census data covers all tax filers instead of only itemizers, whereas SOI  data only include itemizers, sales taxes are included in the tax  collections tables—although they include taxes paid by businesses— and information is available 4 months after the end of a year. This  allows income data reported by aid applicants and tax information  corresponding to the prior year to be used to develop the allowance. A  disadvantage of census data as compared with SOI data is that property  tax information is more limited. Like the SOI data, the tables published  by the BEA and the U.S. Census Bureau reflect aggregate measures of  taxes and income and would not necessarily reflect the experiences of  the typical family. Also, because the BEA and the U.S. Census Bureau  report information in the aggregate—whereas SOI data are separated  into different income bands—Education would need to make  adjustments to differentiate tax rates by income.
U.S. Census Bureau—Current Population Survey (CPS)—Annual Social  and Economic Supplement (ASEC)
Description—The Census Bureau annually publishes the Annual Social  and Economic Supplement to the Current Population Survey, which  includes income, estimated state income taxes, and estimated real  estate taxes. The CPS household income information is gathered  through a survey of 100,000 households. State income tax information  is estimated by the U.S. Census Bureau based on reported income and  filing status information and review of state income tax regulations.  Real estate tax information is generated in a similar manner.  Household characteristics are matched to the Census Bureau’s  American Housing Survey to provide simulated real estate and property  taxes. The CPS dataset and related documentation are available via the  Internet.
Use—Education could use CPS household-level data to generate tax  allowances by income. An advantage of using the CPS is that it allows  Education to estimate the taxes paid by the typical family rather than  the taxes paid in aggregate, and CPS data also reflect the entire  population—itemizers, nonitemizers, and nonfilers. Two disadvantages  are that although we have assessed the information collected by the  U.S. Census Bureau in generating the CPS to be reliable, the CPS tax  information is not based on actual taxes paid but rather on U.S. Census  Bureau tax models and is therefore subject to error and that the CPS  does not include sales taxes. In addition, CPS data are available only  somewhat sooner than SOI data, and because of the size of its sample,  a 3-year average must be taken to generate reliable state-level  information.
Institute on Taxation and Economic Policy (ITEP)—Who Pays? A  Distributional Analysis of the Tax Systems in All 50 States    Description—ITEP is a nonprofit research and education organization  that has published two reports on state taxes, one in 1996 and one in  2003, both entitled Who Pays? A Distributional Analysis of the Tax  Systems in All 50 States. According to an ITEP official, ITEP plans to  publish future updates every 3 years. These reports present estimated  state information on income, real estate, property, and sales tax rates.  The ITEP state tax tables are based on the 1988 public-use SOI sample  of 365,000 federal tax returns, stratified so that they are representative  at the state level and aged to reflect the most recent statistics on  general population and tax filer characteristics published by the IRS  and the U.S. Census Bureau. These returns and state tax regulations are  analyzed to estimate state, local, real estate, property, and sales taxes  paid based on household characteristics. Adjustments are made to  reflect potential nonfilers as well. These reports are available via the  Internet.
Use—Were Education to determine ITEP data reliable, Education  could use the ITEP tax figures to generate tax allowances by income  band. Two advantages of ITEP data are that they include sales taxes  and that an adjustment is made to estimate what nonfilers pay in sales  taxes, whereas SOI data do not reflect sales taxes and do not account  for nonfilers. A disadvantage is that ITEP’s income bands are not  consistent across states and do not match those established by  Congress.
While these publications are publicly available, Education could also  contract with any of these organizations to customize a dataset for the  purpose of developing the tax allowance.
section_title: Apply a Standard Allowance to All Aid Applicants, Regardless of State of Residence
paragraphs: The third strategy would be to apply the same allowance to all aid  applicants, regardless of their state of residence. This would involve  creating a standard allowance based on the CPS that reflects the median  taxes paid by all households. This strategy would have the advantage of  simplifying the need analysis methodology, but a disadvantage is that it  would not account for the variation in taxes paid across states or income  bands. For example, using a standard allowance may on average  underestimate the taxes paid by those from high-tax states but may  overestimate the taxes paid by those from low-tax states.
section_title: Collect Tax Information Directly from Aid Applicants
paragraphs: The fourth strategy would be to collect tax information directly from aid  applicants by adding questions to the financial aid application form. Under  this strategy, applicants would report state and other taxes along with  their federal taxes paid, information that could be used to reduce available  household financial resources directly, making an allowance unnecessary.  While documentation would likely be available for aid applicants to use in  reporting their state income and property taxes, documentation  concerning sales taxes may not be as readily available. Independent of this  report, the Advisory Committee on Student Financial Assistance is  currently assessing this strategy in the context of simplifying the financial  aid application process and is expected to release its report in early 2005.  One of the options considered by the Advisory Committee on Student  Financial Assistance is to have the FAFSA questions tailored to the  applicant, where applicants from different states (and with different  financial circumstances) would answer different questions, and questions  not relevant to an applicant would not be asked. Education officials  expressed concern with this strategy because it might add to the  administrative burden of students, schools, and Education. For example,  Education’s current guidance directs applicants to specific line items from  their federal tax returns for their federal taxes paid, and it would be  difficult to do the same with state taxes, given the variations among state  tax forms. Because institutions are required, on a limited basis, to verify  information reported by students and families on the FAFSA, Education  officials noted that having students and families report additional  information on the FAFSA could increase the burden on institutions of  verifying such information.
section_title: Strategies Would Differ in Terms of Their Effects on Federal Student Aid Expenditures and Financial Aid Applicants
paragraphs: These various strategies would have differed in their impacts on federal  expenditures and on financial aid applicants if they were applied to the  2004–2005 award year. First, each strategy would have changed federal  expenditures for grant and loan programs, for acquiring data, and for other  administrative activities. For example, we estimate that Pell Grant  program expenditures could have increased by as much as $400 million or  decreased by as much as $200 million were the different options adopted  and used to allocate aid for 2004–2005. Second, each strategy would have  affected the amount of federal, state, and institutional aid that financial aid  applicants receive and the number of applicants receiving such aid. For  Pell Grants, using a standard allowance of 4 percent would have caused  about 83,000 recipients to become ineligible for the program, but the other  options would have affected fewer recipients. Table 9 shows the potential  merits of each option in terms of federal expenditures for the Pell Grant  program and the impact on expected family contribution, and table 10  shows the extent to which the tax allowances calculated under each  strategy would accurately reflect state and local taxes paid by students  and families.
section_title: Conclusions
paragraphs: Millions of students rely on federal, state, and institutional aid every year  to help pay for their postsecondary education. These awards are  distributed to students and their families based in part on estimates about  what they can afford to pay out of their own pockets. Yet if these  estimates are considerably incorrect, the awards may not be distributed as  equitably as they could be. Because state and local tax rates may have  changed over the past decade, and Education has updated the allowance  only once and given the limited way in which Education uses SOI data, it is  very likely that the federal government may have been making an  allowance for more taxes than were actually paid, or in other cases,  undercompensating for taxes that were paid. Although Education has  taken some recent steps to update the allowance, these efforts have not  been successful. An inaccurate allowance could yield adverse effects for  the federal government and students and their families. On the one hand,  students and families could erroneously gain eligibility, which would  cause federal funds to be misdirected. On the other, students and families  could inappropriately lose eligibility for aid. Because state and  institutional aid programs also make use of the federal need analysis  methodology, such losses may be compounded for students and families.
section_title: Recommendations for Executive Action
paragraphs: To ensure that relevant tax data from the Statistics of Income are  requested systematically and that the most recent data are obtained, we  recommend, in the short run, that the Secretary of Education develop  formalized updating procedures and document such procedures in writing.  Such procedures could include (1) making annual written requests to the  Internal Revenue Service for state and local tax information and  documenting those requests and (2) coordinating with the IRS to make  sure Education knows when SOI data will be publicly released and to  ensure that the most currently available data are used.
To better capture the amount of taxes paid by students and families, we  also recommend, in the short run, that Education revise its methodology  for calculating the state and other tax allowance. Revisions could include  using tax figures reflective of the different income groups to calculate the  allowance rather than figures based on all itemized tax returns.
To determine whether alternative methodologies and data would better  enable Education to annually update the allowance, we recommend, in the  longer run, that Education assess the cost and reliability of available data,  including the alternative data sources identified in this report. If Education  determines that statutory changes are needed to implement more effective  alternatives, it should seek such changes from Congress.
section_title: Agency Comments
paragraphs: In written comments on our draft report Education generally agreed with  our reported findings and recommendations. In its letter, Education  offered a number of suggestions and observations. Education requested  that we refer to the state tax rates as “‘proposed state tax rates under the  HEA’ in the final report rather than using the label ‘proposed state tax  rates of the Department,’” because it believes it does not have the  authority to “ignore the clear statutory requirement to perform the  update.” Because we explain in our report that the Congress incorporated  the state and other tax allowance in the HEA and required Education to  annually revise the allowance, we do not believe our characterization of  the state tax rates leads to any confusion. Accordingly, we did not change  how we refer to the state tax rates.
Education also commented on the strategies we identified that address  some of the limitations associated with the tax allowance and noted that it  would review each of the alternative data sources discussed in our report  that could be used to substitute for the SOI file data, as we recommended.   Education noted that it believed all four strategies we identified in our  report would likely require congressional action. We agree that those  strategies that involve using alternative data sources to substitute for the  SOI file data would require legislative changes, as we noted in our report.   We also agree with Education’s comment that using income bands other  than those specified by Congress would likely require legislative change.   We disagree that congressional action is required for Education to  continue to use SOI data but with a revised method for calculating the  allowance—one of the strategies identified in our report. While the HEA  directs Education to use the SOI file to revise the allowance, and  establishes the income categories for which the allowance should be  calculated for parents of dependent students and independent students  with dependents other than a spouse (which we define as “families” in this  report), the HEA does not specify a particular method to calculate the  allowance. Therefore, we believe that Education could revise its  methodology, as we recommended, without congressional action.   Education also echoed some of the disadvantages we discussed in our  report associated with applying the same allowance to all applicants and  collecting tax information directly from aid applicants by adding questions  to the application form.
Education also stated that it generally agreed with our assessment of the  impact of the revised allowance tables on Pell Grant recipients but noted  that we could have provided additional information concerning applicants  who would no longer have been eligible for Pell Grants. As we stated in  the report, these applicants typically would no longer have received the  minimum Pell Grant award, reflecting that such applicants typically have  higher incomes than those who would have continued to receive Pell  Grants. Additionally, we show that Pell Grant recipients with household  income over $25,000 would have been significantly more likely to have  either received less in Pell Grants or become ineligible for them.  Education also suggested in its letter that it would be helpful to clarify that  a change in EFC would not necessarily cause an identical change to a  student’s award amount with respect to federal student loans, Campus- Based aid, and state and institutional financial aid programs:  “in other  words,” the department noted, “include a brief explanation of potential  interactive effects.” As noted in our report, our case studies of students at  selected schools showed that as the EFC would have increased, subsidized  loans would have decreased, and unsubsidized loans would have  increased in response to the decreases in other forms of financial aid.  In  response to Education’s comment, however, we added information  concerning how EFC changes would have affected need-based aid overall  with respect to our case study schools. Education also noted that it  understood why we chose to analyze the effects of the proposed 2003  update had it been implemented in 2004–2005. (Soon after we had  submitted our draft report to Education for comment, the department  published, on December 23, 2004, an updated allowance for the 2005–2006  award year.) In its letter, Education includes the results from its  preliminary analysis of the effects of the 2004 update for 2005–2006.   Education’s results are generally consistent with the results from our  analysis. We did not, however, verify the accuracy of Education’s  estimates.
Education also expressed concern that we misinterpreted the  department’s intentions with respect to updating the allowance for the  2005–2006 award year. While we understood the department’s intentions,  we made technical clarifications to the report to address Education’s  concern.
With respect to our recommendation that the department establish formal  procedures to ensure that it annually requests and obtains the most  current tax data from the IRS, Education stated that it had such  procedures in place as “evidenced by the update published in the spring of  2003.” However, as noted in our report, Education could not provide us  with written procedures guiding staff on the routine steps necessary to  update the tax allowance or to identify what data would be needed to  update the allowance. In response to the department’s comment, we  clarified that our recommendation included documenting formalized  procedures in writing. Lastly, Education provided technical comments,  which we incorporated as appropriate. Education’s written comments  appear in appendix V.
As agreed with your offices, unless you publicly announce its contents  earlier, we plan no further distribution of this report until 7 days from its  date. At that time we will send copies of this report to the Secretary of  Education, appropriate congressional committees, and other interested  parties. In addition, the report will be available at no charge on GAO’s Web  site at http://www.gao.gov.
If you or your staff have any questions about this report, please call me on  (202) 512–8403 or Jeff Appel, Assistant Director, on (202) 512–9915. You  may also reach us by e-mail at AshbyC@gao.gov or AppelC@gao.gov.  Other contacts and staff acknowledgments are listed in appendix VI.
section_title: Appendix I: Scope and Methodology
subsections: section_title: Overview
paragraphs: The objectives of this study were to determine (1) what tax data form the  basis of the current tax allowance and what factors have affected regular  updates, (2) the effect the Department of Education’s (Education)  proposed update would have had in award year 2004–2005 on financial  assistance for students and families, (3) the extent to which current  methods for determining the allowance accurately measure how much  students and families have paid in state and other taxes, and (4) the  strategies available to address any problems in deriving the allowance.
To carry out the objectives, we analyzed Education’s 2002–2003 aid  applicant sample file and Education’s Cost Estimation and Analysis  Division’s Statistical Abstract (CEAD STAB), the most current versions  available at the time of our review. We worked closely with financial aid  officials from two states—Tennessee and Wisconsin—and four colleges— one public and one private nonprofit school in each of the two states. We  interviewed officials from the U.S. Department of Education, Advisory  Committee on Student Financial Assistance (ACSFA), and U.S.  Department of the Treasury’s Internal Revenue Service–Statistics of  Income (SOI) Division—as well as officials from the states and schools we  contacted. We also interviewed officials from associations representing  institutions, including the American Association of State Colleges and  Universities (AASCU), National Association of Independent Colleges and  Universities (NAICU) and the College Board, as well as other experts. In  addition, we reviewed and analyzed the statutory requirements and  legislative history of the state and other tax allowance. Furthermore, we  reviewed and analyzed state and other tax data from SOI, Bureau of the  Census, Bureau of Economic Analysis, and the Institute on Taxation and  Economic Policy. We performed our work in accordance with generally  accepted government auditing standards between October 2003 and  November 2004.
section_title: Datasets
paragraphs: In estimating how Education’s proposed update would affect students’ and  their families’ eligibility for financial assistance, we analyzed two datasets.  We used Education’s aid applicant sample file from the 2002–2003 award  year to estimate changes in (a) expected family contribution and Pell  awards nationally, (b) state need-based aid for Wisconsin and Tennessee,  (c) Supplemental Educational Opportunity Grants (SEOG), Perkins loans  and Work-Study, and (d) institutional need-based aid for the four  institutions. This dataset is a randomly drawn, nationally representative  sample of over 450,000 aid applicants. To estimate the percentage of  Stafford subsidized and unsubsidized and Parent Loans for Undergraduate  Students (PLUS) recipients that are likely to have their loan award  changed, we used Education’s CEAD STAB. CEAD STAB is a randomly  drawn, representative sample of 1.8 million borrowers (about 7 million  loans) from the National Student Loan Data System (NSLDS), which is a  comprehensive national database of Title IV loan and grant recipients. Our  analysis of the CEAD STAB focused on Stafford subsidized and  unsubsidized and PLUS borrowers who originated loans from July 2002 to  June 2004. We assessed the reliability of both datasets by conducting  electronic testing of key variables for obvious problems in accuracy and  completeness, interviewing appropriate Education officials, and reviewing  related documentation. Based on these tests and reviews, we determined  that the samples were sufficiently reliable for our purposes.
section_title: Estimation Methodology
subsections: section_title: EFC and Pell Grants
paragraphs: To estimate changes in expected family contribution (EFC) and Pell Grant  awards nationally, our analysis followed Education’s approach to  estimating EFC and Pell awards in the 2004–2005 award year. To do this,  the 2002–2003 aid applicant sample file was converted to better reflect aid  applicants in the 2004–2005 award year by adjusting all income and asset  amounts for inflation and changing the weights assigned to each sample  applicant so that the sample takes into account projected changes in the  number and type of applicants. We reviewed Education’s approach to  converting the sample file to the 2004–2005 award year and calculating  EFC and Pell awards for accuracy and interviewed Education officials  about the approach’s reliability. We determined that Education’s approach  was sufficiently reliable for our purposes.
EFC and Pell awards in the 2004–2005 award year were estimated for each  sample aid applicant using both the current 2004–2005 state and other tax  allowance, which is based on 1988 SOI data, and the proposed 2004–2005  state and other tax allowance, which is based on 2000 SOI data. To assess  the impact of the update on EFC and Pell Grant awards, these amounts  were compared. We also examined how these impacts vary by family  income, dependency status, and state of residence. We designated student  state of residence as the state of residence of the parent(s) when they  differed.
section_title: Stafford and PLUS Loans
paragraphs: Our methodology for obtaining national-level estimates on the percentage  of loan recipients who could have had their loan award affected involved  the steps listed below.  1.  Using the aid applicant sample file, we estimated the percentage of  applicants in award year 2004–2005 who would have had their EFC  changed because of the proposed update for each combination of  dependency status, state of residence, and specified income group.  2.  We used the resulting percentages to estimate the likelihood that each  CEAD-STAB sample borrower’s EFC would have been changed due to  the update.  3.  We estimated the likelihood that each individual borrower would have  had his or her Stafford subsidized and unsubsidized loan award  affected as equal to this percentage if the recipient borrowed less than  the maximum allowed by law. We estimated as zero the likelihood that  each individual borrower would have had his or her Stafford  subsidized and unsubsidized loan award affected if the recipient  borrowed the maximum allowed by law.  4.  For PLUS recipients, the likelihood that each recipient would have had  his or her aid award affected was estimated as equal to the percentage  who would have had their EFC changed because of the proposed  update that we estimated from our analysis of the aid applicant sample  file.
Estimating whether students would have seen a change in their loan  amounts because of the proposed update is complex largely because these  loan amounts depend on the extent to which all other financial aid  awards—including Campus-Based, state, and institutional aid—would  have been affected, and no complete information is available on the  specific awarding policies of all states and institutions for these types of  aid. To compensate for this lack of information, we made several  assumptions regarding how Stafford and PLUS loans would have been  affected, which may either over- or underestimate what the actual changes  would have been. However, these assumptions may somewhat offset each  other, and we believe our estimates are informative of the percentage of  borrowers whose loan awards could have been affected.
Stafford and PLUS loan estimates may be biased upward for the following  reasons. Stafford loan estimates may be biased upward because we  assumed that all borrowers who currently receive less than the maximum  allowed and whose EFC would have changed under the proposed update  would have had their loan award amount changed as well, yet this is not  always the case. For example, because the subsidized loan award equals  the cost of attendance less EFC and other financial aid awards, subject to  the loan limits, subsidized Stafford loan amounts would not have been  affected if the decrease in other financial aid awards exactly offset the  EFC increase resulting from the proposed update. Because the  unsubsidized Stafford loan award equals the cost of attendance less other  financial aid awards (including subsidized loan awards), subject to the  loan limits, unsubsidized loan amounts would not have been affected if  other aid awards did not change because of the update. Furthermore, we  assumed that all PLUS borrowers whose EFC would have changed  because of the update would have had their loan award affected, but,  similar to unsubsidized Stafford loans, this would not have occurred had  other aid awards not changed because of the update. It is difficult to know  the size of this upward bias because the dataset does not include  information on the extent to which other financial aid awards would have  been affected.
Our estimates for Stafford loans may be biased downward because we  assumed that all borrowers who receive the maximum allowed would not  have had their loan award affected, which also is not always the case. For  unsubsidized Stafford loans, this bias appears to be very small because  unsubsidized loans would only decrease if students have a cumulative net  increase in their other financial aid awards, which case studies and expert  interviews show to be unlikely. For subsidized Stafford loans, this bias  may be larger, yet we believe that it is still relatively small. Subsidized  Stafford loan awards that are currently at the maximum would only  decrease when the EFC plus other aid increase enough to cause the  student to lose eligibility for the maximum loan amount, and analysis of  the National Postsecondary Student Aid Survey (NPSAS) shows that most  students are not likely to face this circumstance.
We also assumed that the borrowers in award year 2004–2005, the year of  the proposed update, are from the same states, have the same incomes,  and have the same costs of attendance as the most recent CEAD-STAB  borrowers, and the extent to which they differ would cause our estimates  to be less accurate. For example, if we underestimate the number of  students in likely high-impact states, our estimates would likely  underestimate the overall proportion of students who could face a change  in their loan award.
To complement this national-level loan analysis, we determined the  percentage of students at our case study schools who would have  experienced a change in their subsidized and unsubsidized loans, along  with the size and direction of the changes. We could not determine this  information for PLUS loans for our case study schools since the schools  did not package PLUS loans for the purpose of estimating potential  impacts of the proposed update.
section_title: State and Institutional Need-Based Aid and Campus-Based Aid
paragraphs: To provide illustrative examples of how the proposed update can affect  state and institutional need-based aid and Campus-Based aid, we worked  closely with two states—Wisconsin and Tennessee—and four colleges,  including one public and one private nonprofit institution in each of the  two states. We chose these states because they use the Higher Education  Act (HEA) federal methodology to disburse state aid, are geographically  dispersed, and represent high- and low-impact states, based on an index  we calculated for the following components: (1) the average EFC change  resulting from Education’s update, (2) the percentage of full-time  undergraduates receiving grant aid, and (3) the average state need-based  grant per undergraduate. We averaged the three components to generate  an index of the overall average impact. The 44 states and the District of  Columbia that use the federal methodology were then sorted in  descending index order and separated into three groups of 15, with the  highest index group being designated “high-impact states,” the next group  being designated “medium-impact states,” and the last group being  designated “low-impact states.” For the components and index value we  estimated for each state, see appendix II. The institutions we chose  include the University of Wisconsin at Madison, Wisconsin’s Marian  College, Middle Tennessee State University, and Tennessee’s Carson- Newman College. We chose schools within the two selected states based  on the following criteria: (1) use of the HEA federal methodology to  disburse aid, (2) participation in the federal Campus-Based aid program,  (3) provision of institutional need-based aid, (4) number of students with  household income between $25,000 and $75,000, and (5) willingness and  capacity to calculate estimated impacts on need-based aid.
For each of these two states and four institutions, we generated a  subsample from Education’s aid applicant sample file that reflects the  students who attended school in these two states and the students who  attended school at the four institutions in the 2002–2003 award year. For  each student, the dataset contained information on the student’s estimated  EFC under the current and proposed allowance and the student’s  dependency status. Using these subsamples, examples of the effect of the  proposed update on state, institutional, and Campus-Based aid were  calculated. While the aid applicant sample file is a nationally  representative sample, it may not be representative of the aid applicants  who attend school in these specific states or at these specific institutions.  The subsamples had the following number of observations:     Wisconsin: 7,469,     Tennessee: 8,385,     University of Wisconsin at Madison: 580,     Wisconsin’s Marian College: 54,     Middle Tennessee State University: 533, and     Tennessee’s Carson-Newman College: 62.
We estimated the impacts on Wisconsin’s state need-based aid using the  Wisconsin subsample, along with the state aid award methodologies  provided to us by the Wisconsin Higher Educational Aids Board. The state  need-based aid programs that we analyzed were the Wisconsin Higher  Education Grant and the Wisconsin Tuition Grant programs.
The Tennessee Student Assistance Corporation, the agency responsible for  determining state aid in Tennessee, performed its own analysis of the  impact on state need-based aid using the Tennessee subsample and then  shared the results with us. The aid program analyzed was the Tennessee  Student Assistance Award. To verify the validity of the Tennessee aid  determination, we verified that the aid awarded fell within the maximum  award limit and that those within an EFC range received similar award  amounts; that is, that those with a lower EFC received a higher award  amount.
To estimate the impacts on institutional need-based and Campus-Based  aid, financial aid directors or financial aid specialists at each of the four  selected schools calculated the impacts using their relevant subsample.  While the focus was on need-based institutional aid and Campus-Based  aid, three institutions also calculated the effect on Stafford loans. To  check the validity of these simulations, we checked (1) the order in which  different forms of aid were awarded to see if they were consistent with  common aid packaging protocols, (2) the formulas used to calculate  remaining need at each stage of the award packaging process to make sure  they were accurate, (3) the range of aid levels awarded to make sure they  fell within bounds defined by regulation, (4) the total aid awarded to make  sure it did not exceed financial need, and (5) the relationship between aid  awarded and EFC levels to make sure that those with lower EFCs were  provided more aid than those with higher EFCs.
section_title: Calculation of Estimated Tax Rates from Alternative Data Sources
subsections: section_title: Methodology
paragraphs: For the purposes of this report, we define “families” to include parents of  dependent children (students) and independent students with dependents  other than a spouse, and we define “individuals” to include dependent  students and independent students without dependents other than a  spouse. The specific methodologies used for each source are described in  the footnotes to table 9.
section_title: Reliability Assessment
paragraphs: In assessing the reliability of state personal income estimates from the  U.S. Bureau of Economic Analysis (BEA), we reviewed information  available online from the BEA Web site on its data quality assurance  processes and interviewed relevant officials. On the basis of the results of  our document review and discussions with relevant officials, we  concluded that the BEA data we used were reliable for our purposes for  this analysis.
In assessing the reliability of state government tax collections estimates  from the U.S. Census Bureau, we interviewed relevant officials, who stated  that there was no published data reliability documentation. Thus, we were  unable to determine if the Census data we used were reliable for our  purposes for this analysis.
In assessing the reliability of data from the U.S. Census Bureau’s Annual  Social and Economic Supplement, we reviewed information available  online from the U.S. Census Bureau Web site on its data quality assurance  processes and interviewed relevant officials. On the basis of the results of  our document review and discussions with relevant officials, we have  determined that the information collected by the U.S. Census Bureau in  generating the Current Population Survey (CPS) is reliable, but we were  unable to determine whether the CPS tax data we used, which is not  collected directly but rather generated from U.S. Census Bureau tax  models, were reliable for our purposes for this analysis.
In assessing the reliability of data from the Institute on Taxation and  Economic Policy’s Who Pays publication, we interviewed a relevant  official and reviewed available documentation. However, we were unable  to reach a determination as to the reliability of the data, primarily because  of a lack of sufficient documentation.
section_title: Sampling Error
paragraphs: Because our analysis relied on samples of aid applicants and borrowers,  our estimates are subject to sampling errors. Sampling errors are often  represented as a 95 percent confidence interval: an interval that 95 times  out of 100 will contain the true population value. For the percentages and  numbers presented in this report on the EFC, Pell award, Stafford loan,  and PLUS loan impacts, we are 95 percent confident that the results we  would have obtained had the entire population been studied are within  plus or minus 5 percent of the results, unless otherwise noted. The results  for state and institutional need-based aid and Campus-Based aid are not  necessarily based on representative samples and therefore should be  considered as case study findings, or illustrative examples. Thus, we did  not calculate sampling errors for these three categories of aid.
section_title: Appendix II: State Selection Matrix—Ranking of Potential Impact of Proposed Allowance, Listed by Category
paragraphs: Report on State-Sponsored Student Financial Aid, 2001-02 Academic Year.
section_title: Appendix III: Average Tax Rates on Adjusted Gross Income, by State and Income Level
paragraphs: Appendix III: Average Tax Rates on Adjusted  Gross Income, by State and Income Level level (percentage) level (percentage)
section_title: Appendix IV: Simulation of Tax Allowance Percentages under Various Options, by State—Families with Adjusted Gross Income of $15,000 or More
paragraphs: Appendix IV: Simulation of Tax Allowance  Percentages under Various Options, by  State—Families with Adjusted Gross Income  of $15,000 or More allowance (4%)
4 allowance (4%)
section_title: Appendix V: Comments from the Department of Education
section_title: Appendix VI: GAO Contacts and Staff Acknowledgments
subsections: section_title: GAO Contacts
section_title: Staff Acknowledgments
paragraphs: In addition to those named above, the following people made significant  contributions to this report: Jeff Weinstein, Cynthia Decker, Bob Parker,  Sue Bernstein, Amy Buck, James Wozny, and Melba Edwards.