Department of Education's Update of the State and Other Tax Allowance for Student Aid Award Year 2005-2006

This letter responds to a Congressional request concerning our January 21, 2005, report Student Financial Aid: Need Determination Could Be Enhanced through Improvements in Education's Estimate of Applicants' State Tax Payments (GAO-05-105). 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, including Pell Grants and student loans, and some state and institutional aid are awarded based on a 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 nonfederal taxes paid by students and families, effectively reduces the EFC. Education proposed to update the allowance on the basis of information compiled by the Internal Revenue Service's Statistics of Income (SOI) Division, specifically state and other taxes paid by taxpayers and reported on their federal income tax returns for tax year 2000. Our January 2005 report discussed (1) the factors that had affected the updating of the tax data on which the allowance is based, (2) the effects Education's proposed 2003 update would have had on financial assistance for student aid applicants for the 2004-2005 award year, (3) the limitations associated with the method used to derive the allowance, and (4) various strategies available to address the limitations. Although the proposed 2003 update to the state and other tax allowance did not take effect, shortly before we issued our report--on December 23, 2004--Education updated the state and other tax allowance for award year 2005-2006 on the basis of information compiled by SOI for tax year 2002, which was collected in the same manner as the tax year 2000 data. For this update, Education used the same methodology that was used for the proposed 2003 update. As of January 2005, Education has begun processing student aid applications for the 2005-2006 award year using the updated allowance. In light of Education's 2004 update of the state and other tax allowance for award year 2005-2006, Congress asked us to update certain analyses included in our January 2005 report, which focused on Education's prior proposal. In particular, we determined how Education's update will affect, with respect to the 2005-2006 award year, (1) the state and other tax allowance, by state and dependency status; (2) the average EFC, by state; (3) eligibility for Pell Grants, by state, household income, and dependency status; (4) the amount of the average Pell Grant award, by state, household income, and dependency status; and (5) aggregate Pell Grant expenditures and overall student eligibility for Pell Grants. Congress also asked us to include the effects if Education had adopted one of the strategies discussed in our report for addressing the limitations associated with calculating the allowance.

Education's 2004 update decreases the state and other tax allowance for most states for the 2005-2006 award year and will, thereby, increase the expected family contribution (EFC) for a majority of student aid applicants; the increase in expected family contribution will, in turn, affect the allocation of federal aid. Specifically, we estimate that the 2004 update to the state and other tax allowance will increase EFCs by about $440 on average for those with an increase, with EFC changes being larger for students from states with larger changes in their allowance. With respect to Pell Grants, our national analysis shows that the 2004 update will likely result in a decrease in Pell Grants for about 35 percent of students, and an additional 81,000 applicants (1.5 percent) will no longer be eligible for the grant; taken together, the average reduction amongst those with a decrease in their amount will be about $130. Collectively, this will decrease overall Pell Grant expenditures by about $250 million. Because these EFC changes will affect Pell and other grant aid, Stafford and PLUS loan award amounts will be affected as well. Our analysis shows that, as EFCs increase, those with income above $25,000 are most likely to have their subsidized Stafford loan awards affected. The overall impacts on EFC, Pell Grants, and loans will be slightly less when compared to what would have occurred under the proposed update of 2003. In our January 2005 report, we identified four strategies to address some of the limitations associated with the tax allowance. Using an updated sample of aid applicants and tax data, these options would have ranged in their impact on federal expenditures for the Pell Grant and other federal programs. For example, depending on the option chosen, the effect would have ranged from a $200 million decrease in Pell Grant expenditures to a $200 million increase in the 2005-2006 award year.