Tough Choices Ahead on College Aid Plan

article | September 20, 2007

The massive college aid bill that Congress passed earlier this month is headed to the President for signature. As the newest member of the Higher Ed Watch team and a budget hawk, I thought I would point out some of the loose ends that are going to have to be tied up in the near future if the bill is to live up to its dual promise of increasing student financial aid without imposing any new costs on taxpayers.

The first promise: The bill increases student financial aid by more than $20 billion. Indeed it does. Consider the two largest new sources of aid, more Pell Grant money and lower interest rates on some student loans. The bill provides $11.4 billion over five years to support bigger Pell Grants for needy students, and, at a cost of $6.1 billion over the next five years, it gradually lowers for undergraduates the interest rate paid on subsidized Stafford student loans taken out in the coming years from the current fixed 6.8 percent level to 3.4 percent.

The second promise: Increases in student aid will be provided "at no new cost to taxpayers." This is also true. The bill reduces taxpayers subsidies provided to lenders and guarantee agencies making federal student loans and redirects those funds to pay for more student aid. The cuts - $22 billion over the next five years - are more than enough to cover the full cost of the increased student aid, so the bill doesnt cost taxpayers any new money on a net basis.

Thus, it appears that the bill makes good on its promises. But there are some details in the new college aid bill that could, depending on how Washington addresses them later, make Congress a promise breaker.

It turns out that the new bill's shift of taxpayer money from lender subsidies to increased student financial aid isn't enough to cover the full cost of all of the benefits that Congressional leaders originally wanted to provide, particularly with respect to the planned student loan interest rate cut and Pell Grant boost. Early on, the bill's drafters realized they had two choices: either cut lender subsidies even further to cover the promised levels of student aid or somehow make the cost of the student benefits fit within the money available. They chose the later option, because they were concerned that cutting lenders subsidies further would either make federal student loans unprofitable for private lenders or engender too much political pushback. The graphs below show how the bill makes the additional Pell Grant aid and cost of the interest rate cut fit within the money freed up by the lender subsidy reductions.

Under the new college aid bill, mandatory Pell Grant funding increases each year until it hits $5.1 billion in 2012 and then mandatory spending for Pell students falls off a cliff in 2013 to $105 million. In 2014 it is funded again, but at a lower level than it reached in 2013. A freshman college student in 2012 will have a much lower Pell Grant in her last three years of college, if Congress doesn't later backfill this projected cut. The graph below shows that Congress will need to spend $9 billion more than the bill provides to maintain the Pell Grant funding at the level it is to reach in 2012. Of course, Congress could pass a new bill that provides the additional aid, but it will need to be offset by spending reductions, otherwise the new student aid provided in the reconciliation bill will cost taxpayers new money -- six years from now. If the additional aid is provided by deficit spending (i.e. no offset or tax increase) I'd consider that a failure to keep the promise of no new cost to taxpayers as well. Higher deficits require more debt and interest payments supported by taxes. Of course the deficit could be lower in six years, but no one is betting on that in Washington right now.

Regardless, the same phenomenon is present with the planned borrower interest rate cut. The interest rate cut from 6.8 percent to 3.4 percent has to be phased in slowly over the coming years, otherwise the costs will be too high to fit within Congress' lender subsidy reduction offset. But absent future Congressional action,loans taken out in 2012 and thereafter will carry interest rates at the present 6.8 percent level. Maintaining the 3.4 percent interest rate on loans taken out after 2011 would cost an additional $17 billion over the 10 year period covered in the college aid reconciliation bill. Again, Congress could enact new legislation that prevents the rate from reverting to 6.8 percent, but unless the full cost of that benefit is offset by other spending reductions, the reconciliation bill will cost taxpayers new money.

In short, the Democratic Congress has taken a page from the Bush 2001 tax cut playbook. (The Bush Administration no doubt followed an earlier precedent doing the same). Just like the Bush tax cuts that expire in 2011, the Democratic Congress boosted student financial aid now and for a not insignificant five year period knowing that when the policy expires in 2013, there will be significant pressure to extend it. How theyll do it, or even if they'll do it, remains to be seen.

But if Congress wants to keep both of its promises - more student financial aid and no new costs to taxpayers - over the long term, a new group of Members is going to have to find and pass some new offsets. As with the Bush 2001 tax cut, it's not going to be easy.

[Disclosure: The author formerly worked for Senator Judd Gregg (R-NH), who voted against the legislation referenced herein.]