    Student Financial Aid: Need Determination Could Be Enhanced
    through Improvements in Education's Estimate of Applicants' State
    Tax Payments (21-JAN-05, GAO-05-105).

    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.
    -------------------------Indexing Terms-------------------------
    REPORTNUM:   GAO-05-105
        ACCNO:   A16016
      TITLE:     Student Financial Aid: Need Determination Could Be
    Enhanced through Improvements in Education's Estimate of
    Applicants' State Tax Payments
         DATE:   01/21/2005
      SUBJECT:   Aid for education
    	     Data integrity
    	     Educational allowances
    	     Federal funds
    	     Federal grants
    	     Internal controls
    	     Student financial aid
    	     Student loans
    	     Taxes
    	     Work-study programs
    	     Department of Education PLUS Loan
    	     Program

    	     Dept. of Education Perkins Student Loan
    	     Program

    	     Dept. of Education Stafford Student Loan
    	     Program

    	     Dept. of Education Supplemental
    	     Educational Opportunity Grants

    	     Free Application for Federal Student Aid
    	     Pell Grant

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    GAO-05-105

    United States Government Accountability Office

    GAO

                           Report to Congressional Requesters

    January 2005

    STUDENT FINANCIAL AID

        Need Determination Could Be Enhanced through Improvements in Education's
                       Estimate of Applicants' State Tax Payments

    GAO-05-105

    [IMG]

    January 2005

    STUDENT FINANCIAL AID

    Need Determination Could Be Enhanced through Improvements in Education's
    Estimate of Applicants' State Tax Payments

                                     What GAO Found

    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.

    Percentage of Recipients Who Would Have Seen a Pell Grant Reduction with
    the Proposed Update, by Household Income

    Household income (dollars)

    0-25,000

    25,001-50,000

    0 20 40 60 80 100

    Source: GAO analysis of the Free Application for Federal Student Aid
    (FAFSA) applicant file.

    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.

                     United States Government Accountability Office

    Contents

    Letter

    Results in Brief
    Background
    The Current Tax Allowance Is Based on 1988 Data Due In Part to

    Education's Limited Efforts in Updating the Allowance

    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

    The Current Allowance May Not Capture the Taxes Paid Due to the
    Type of Data and Methodology in Use

    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

    Conclusions
    Recommendations for Executive Action
    Agency Comments

                                           1

                                          3 6

    11

    15

    27

    31 39 39 40

    Appendix I Scope and Methodology 44

    Overview 44
    Datasets 44
    Estimation Methodology 45
    Calculation of Estimated Tax Rates from Alternative Data Sources 50
    Sampling Error 51

    Appendix II 	State Selection Matrix-Ranking of Potential Impact of
    Proposed Allowance, Listed by Category

    Appendix III 	Average Tax Rates on Adjusted Gross Income, by State and
    Income Level

    Appendix IV	Simulation of Tax Allowance Percentages under
    Various Options, by State-Families with Adjusted
    Gross Income of $15,000 or More 55

                Appendix V Comments from the Department of Education 57

    Appendix VI GAO Contacts and Staff Acknowledgments

    61

    GAO Contacts 61 Staff Acknowledgments 61

    Tables

    Table 1: State and Other Tax Allowance Established for Parents of
    Dependents and for Independents with Children, Published in 1993

    Table 2: State and Other Tax Allowance Established for Dependents and
    Independents without Children, Published in 1993

    Table 3: Proposed Allowance Changes and Estimated EFC Impacts by State

    Table 4: Percentage with a Pell Grant Decrease and Average Decrease by
    State, Including Those No Longer Eligible for the Award

    Table 5: Estimated Impacts in Campus-Based Aid for Case Study Schools

    Table 6: Estimated Impacts in State Need-Based Aid for Two States

    Table 7: Publication Dates of SOI State and Local Tax Data

    Table 8: Comparison of Income Distribution in 2001 of FAFSA Applicants and
    Federal Income Tax Itemizers

    Table 9: Framework for Evaluating Options Identified to Change the State
    and Other Tax Allowance Relative to the Current Allowance in Use 12

    13

    17

    19

    25 26 29

    30

    37

    Figures

    Figure 1: Federal Student Need Analysis Methodology 7 Figure 2: Estimated
    Amount of Student Aid Awarded in 2003-2004,

    by Source of Aid 10 Figure 3: Percentage of Recipients with a Decrease in
    Pell Award 21 Figure 4: Median Percentage Change in Amount of Pell Award
    for

    Those with a Decrease 22 Figure 5: Percentage of Students Likely to Have
    Had a Change in Subsidized Stafford Loans 24

    Figure 6: Framework for Evaluating the Alternative Datasets

    Identified Relative to SOI Data

    38

    Abbreviations

    ACSFA Advisory Committee on Student Financial Assistance
    AGI adjusted gross income
    ASEC Annual Social and Economic Supplement
    AY award year
    BEA Bureau of Economic Analysis
    CEAD STAB Cost Estimation and Analysis Division Statistical Abstract
    COA cost of attendance
    CPS Current Population Survey
    EFC expected family contribution
    FAFSA Free Application for Federal Student Aid
    FY fiscal year
    HEA Higher Education Act
    IM Institutional Methodology
    IRS Internal Revenue Service
    ITEP Institute on Taxation and Economic Policy
    NSLDS National Student Loan Data System
    PLUS Parent Loans for Undergraduate Students
    SEOG Supplemental Educational Opportunity Grant
    SOI Statistics of Income

    This is a work of the U.S. government and is not subject to copyright
    protection in the United States. It may be reproduced and distributed in
    its entirety without further permission from GAO. However, because this
    work may contain copyrighted images or other material, permission from the
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    separately.

    United States Government Accountability Office Washington, DC 20548

    January 21, 2005

    Congressional Requesters

    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.1 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.

    1Title IV aid programs include Pell Grants, subsidized and unsubsidized
    Stafford loans, and Parent Loans for Undergraduate Students (PLUS), as
    well as Supplemental Educational Opportunity Grants (SEOG), Perkins loans,
    and Work-Study aid funded by the federal government and administered by
    participating institutions, commonly known as Campus-Based aid. About $68
    billion in aid was provided under Title IV programs during fiscal year
    2003-2004; in addition, the College Board estimates that about $29 billion
    was provided under state and institutional aid programs during award year
    2003-2004.

    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) 2 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.

                                    Results in Brief

    The current tax allowance is based on 1988 tax data due in part to
    Education's limited efforts to update the allowance. Congress incorporated
    the allowance into law in 1986 but did not establish a mechanism for
    updating the allowance until 1992. In amending the Higher Education Act in
    1992, Congress directed Education to annually revise the allowance tables
    after reviewing the IRS' Statistics of Income file and determining the
    percentage of income that each state's taxes represent for those
    residents. While Education has published allowance tables annually since
    1993, prior to 2004, it attempted to update the allowance tables
    twice-once in 1993 and once in 2003-but the latter update was suspended.
    As a result, the allowance-based on 1988 data that was first incorporated
    into the allowance tables in 1993-continued to be based on 1988 data. One
    reason the allowance was not updated more frequently was because Education
    did not annually seek data needed to update the allowance. For example,
    Education records indicate that it only sought data to update the
    allowance for 6 years of the 11-year period from 1993 to 2003. Another
    reason is that Education was unwilling to incur costs to acquire data and
    therefore did not consider alternatives when data were unavailable
    cost-free. Further, when the IRS did make more current tax data freely
    available via the Internet, starting in 2000, Education did not become
    aware of this fact and did not take steps to make use of the data until
    2003. In addition, Education could not provide us with written procedures
    guiding staff on the routine steps necessary to update the tax allowance,
    nor did it maintain detailed records of its efforts to obtain data.

    Education's proposed update would have decreased the state and other tax
    allowance for most states, which, in turn, would have increased the
    expected family contribution for a majority of student aid applicants; the

    2ACSFA was established by Congress with the enactment of the 1986 HEA
    amendments. The committee began its operation in 1988 by serving as a
    source of advice and counsel to Congress and the Secretary of Education on
    student financial aid policy.

    increase in expected family contribution would have, in turn, affected the
    allocation of federal aid and potentially state and institutional aid as
    well. We estimate that the update to the state and other tax allowance
    would have affected over half of the students applying for aid by
    increasing their EFC by about $500 on average (or from an average of about
    $9,620 to about $10,115) for those who would have had an EFC increase. The
    amount of the EFC increase generally would have been larger for students
    from states with a larger decrease in their state and other tax allowance.
    For example, residents of Delaware, which would have had a 4 percentage
    point decrease in its allowance for families-the largest decrease among
    the states-would have experienced an EFC increase of about $830 on
    average. With respect to Pell Grants, our national analysis shows that EFC
    increases from the update would have likely resulted in a decrease in Pell
    Grant awards for about 36 percent of students, and an additional 92,000
    applicants (2 percent) would no longer have been eligible for the grant.
    Because these EFC changes would have affected Pell and other grant aid,
    Stafford and PLUS loan award amounts would in turn have been affected as
    well. Our case studies show that as EFC would have increased, subsidized
    Stafford loan awards would have decreased while unsubsidized Stafford loan
    awards would have increased. However, these case studies also show that
    most federal Campus-Based aid awards would have largely been unaffected by
    changes in the EFC. The effect of EFC changes on state and institutional
    grants would have varied because the EFC would have decreased in some
    states more than in others and because aid policies vary across states and
    institutions.

    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 fully reflect
    the amount of taxes paid by students and families. The dataset itself is
    not ideally suited for calculating the allowance because it is limited to
    financial data from those who itemize their taxes, does not include state
    and local sales taxes, and is several years older than the income
    information reported by students and families on the FAFSA. SOI tax
    information may not be representative of families applying for financial
    aid because SOI compiles state and local tax data only for those who
    itemize their deductions, and itemizers may pay different effective tax
    rates for a given level of income than nonitemizers. Also, while state and
    local sales taxes were reflected in SOI data when Congress first
    incorporated the tax allowance, subsequent tax reform legislation
    eliminated the deductibility of sales taxes, effectively removing this
    information from the SOI dataset. Although more recent legislation
    provides taxpayers who itemize the choice of deducting either sales or

    income taxes, the law allows this only for the 2004 and 2005 tax years.
    Moreover, SOI tax data are generally released about 2 years after each tax
    year, so it is not possible to match this information with the income
    information that applicants report on the aid application. In addition to
    the limitations of the SOI dataset, Education's calculation of the
    allowance does not accurately consider the varying taxes paid by different
    income groups. As a result, Education's calculation of the allowance is
    overestimated for lower-income groups and underestimated for higherincome
    groups.

    We identified four strategies to address some of the limitations
    associated with the tax allowance. While not exhaustive, these strategies
    include (1) continuing to use SOI data but with a revised method for
    calculating the allowance, (2) substituting SOI data with data from one of
    several alternative sources, (3) using the same allowance for all aid
    applicants without regard to state of residence, and (4) collecting
    information directly from the aid applicants themselves. The calculation,
    for example, might be modified to better reflect the taxes paid by
    different income groups than the current methodology. An option that would
    not require calculating an allowance would be to collect information about
    actual taxes paid directly from aid applicants by adding questions to the
    aid application, making it possible to collect income, asset, and tax
    information for the same year. Selecting among these strategies would
    require a number of considerations: the effect on federal expenditures,
    the impact on aid applicants, and the availability and reliability of tax
    data from alternative sources. These options could range in their impact
    on federal expenditures for the Pell Grant and other federal programs. For
    example, depending on the option chosen, the effect would range from a
    $200 million decrease in Pell Grant expenditures to an increase of $400
    million in the 2004-2005 award year.

    In this report, we recommend that the Secretary of Education improve the
    department's process for updating the state and other tax allowance by
    formalizing procedures, and documenting them in writing, to ensure that
    the Department of Education annually requests and obtains the most current
    tax data from SOI and revise the methodology for calculating the state and
    other tax allowance to more accurately consider the varying taxes paid by
    students and families. In addition, we recommend that the Secretary
    determine whether alternative methodologies and/or data- including those
    identified in this report-would allow the department in the future to more
    effectively calculate and update an allowance for state and other taxes.

    Background 	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.

    Federal Need Analysis Methodology

    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.)

                  Figure 1: Federal Student Need Analysis Methodology

    Source: GAO analysis of the HEA.

    Note: Not all assets are considered under the federal student need
    analysis methodology. For example, the methodology does not include the
    principal place of residence.

    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.

    Federal Aid Provided under Title IV of the Higher Education Act

    Title IV of the HEA, as amended, authorizes the following federal aid
    programs:

    o  	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.

    o  	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).

    o  	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.

    o  	Unsubsidized Stafford Loans-Unsubsidized Stafford loans are
    nonneed-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.

    o  	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.

    o  	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:

    o  	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.

    o  	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.

    o  	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.

    Students Received about Students received an estimated $98 billion in
    financial aid in award year $98 Billion in Federal, 2003-2004 from the
    Title IV federal aid programs as well as state and State and Institutional
    Aid institutional grants, of which the federal government provided more
    than in 2003-2004. 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.3 Institutions provided about $23 billion in the forms of
    needbased grant and merit-based aid. (See fig. 2.)

    Figure 2: Estimated Amount of Student Aid Awarded in 2003-2004, by Source of Aid

    3

    Federal Campus-Based Aid State Grants

    Federal Pell Grants

    Institutional Grants

    Federal Loans

                                 In billions of dollars

    Source: Department of Education, Fiscal Year 2005, Justifications of
    Appropriation Estimates to the Congress, Volume II. College Board, Trends
    in Student Aid, 2004.

    Notes: Federal aid is based on fiscal year figures, and state and
    institutional aid is based on award year amounts. Because of rounding, the
    sum of aid awarded under the various programs in the figure above is less
    than the actual total of $97.9 billion.

    3The College Board estimates that about 75 percent of state aid was
    need-based.

    The Current Tax Allowance Is Based on 1988 Data Due In Part to Education's
    Limited Efforts in Updating the Allowance

    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.

    The Current Tax Allowance Is Based on 1988 Tax Data

    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[s] of State and other tax allowances"
    annually, and to "develop such revised table[s] 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.

    Table 1: State and Other Tax Allowance Established for Parents of
    Dependents and for Independents with Children, Published in 1993

                      Income level (percentage) State of residence

    Less than $15,000

    $15,000 or more

    Alaska, Nevada, Tennessee, Texas, Wyoming 3

    Florida, Louisiana, South Dakota, Washington 4

    Alabama, Mississippi 5

    Arizona, Arkansas, Connecticut, Illinois, Indiana, Missouri,
    New Mexico, North Dakota, Oklahoma, West Virginia 6

    Colorado, Georgia, Idaho, Kansas, Kentucky, New
    Hampshire, Pennsylvania 7

    California, Delaware, Hawaii, Iowa, Montana, Nebraska, New Jersey, North
    Carolina, Ohio, South Carolina, Utah, Vermont, Virginia 8

    Maine, Maryland, Massachusetts, Michigan, Minnesota,
    Rhode Island 9

    District of Columbia, Oregon, Wisconsin 10

    New York 11

    Other areas 4

                             Source: 1993 Federal Register.

    Table 2: State and Other Tax Allowance Established for Dependents and
    Independents without Children, Published in 1993

    State of residence

    Percentage

    Alaska, Nevada, South Dakota, Tennessee, Texas, Washington, Wyoming

    Florida, New Hampshire

    Connecticut, Illinois, Louisiana, North Dakota

    Alabama, Arizona, Mississippi, Missouri, New Jersey, Pennsylvania

    Arkansas, Colorado, Georgia, Indiana, Kansas, Michigan, Nebraska, New
    Mexico, Oklahoma, Rhode Island, Vermont, Virginia, West Virginia

    California, Delaware, Idaho, Iowa, Kentucky, Maine, Massachusetts,
    Montana, North Carolina, Ohio, South Carolina, Utah, Wisconsin

    Hawaii, Maryland, Minnesota, Oregon

    District of Columbia, New York

    Other areas

    Source: 1993 Federal Register.

    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.4

    4On December 23, 2004, about 6 months past the deadline specified by the
    HEA for updating the allowance, Education published updated state and
    other tax tables for award year 2005-2006 using 2002 SOI tax data.
    According to Education, it delayed the publication of these tables in
    order to complete a thorough review of available SOI information and to
    consider the findings of a congressionally mandated review by the Advisory
    Committee on Student Financial Assistance on the efficiency,
    effectiveness, and fairness of current procedures to update formula
    offsets and allowances.

    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

    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.5 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.6 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

    5Education did not have records to show that it had requested SOI data in
    1997, 1998, 2000, 2001, and 2002.

    6According to SOI officials, Education had options in obtaining the data.
    Requesting SOI to tabulate state and other taxes from all tax returns
    would have been a lower-cost option because SOI already had the procedures
    in place to make this tabulation.

    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

    allowance.7 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.8

    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.

    7SOI currently provides state and other tax data by state for tax years
    1997 to 2002 on its Web site.

    8GAO, Standards for Internal Control in the Federal Government,
    GAO/AIMD-00-21.3.1 (Washington, D.C.: November 1999).

    Under the Proposed Update, Expected Family Contributions Would Have
    Increased by about $500, on Average, for a Majority of Student Aid
    Applicants

    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.9 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
    more10-from 7 percent to 3 percent-and a 2 percentage point decrease for
    individuals,11 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.

    9The percentage of those with a decrease in the amount they are expected
    to contribute is less than 1 percent.

    10"Families" includes parents of dependent students and independent
    students with children.

    11"Individuals" includes dependent students and independent students
    without children.

    Table 3: Proposed Allowance Changes and Estimated EFC Impacts by State

                      Percentage point change                           Estimated
                   in the state and other tax     percentage of Estimated average
                           allowance                  students with an EFC dollar
                                                   increase in their increase for
                                                                            those
             State       Families Individuals                EFC with an increase

                                  Alabama -2 -1 59 311

                                   Alaska -1 0 62 261

                                  Arizona -2 0 47 385

                                 Arkansas -3 -1 62 410

                                 California -2 0 45 406

                                 Colorado -3 -1 75 571

    Connecticut 0 +2 1

                                 Delaware -4 -2 80 834

    District of -3 -1 60 485 Columbia

                                  Florida -2 -1 64 298

                                  Georgia -2 -1 67 384

                                  Hawaii -4 -2 68 746

                                   Idaho -2 -1 69 321

                                  Illinois -2 0 60 459

                                  Indiana -2 -1 75 406

                                   Iowa -4 -2 78 781

                                  Kansas -3 -1 77 531

                 Kentucky            -2          -1         66             340
                Louisiana            -2          -1         61             415
                  Maine              -3          -1         78             610
                 Maryland            -2          -1         75             462
              Massachusetts          -3          -1         79             717
                 Michigan            -4          -1         73             746
                Minnesota            -3          -2         81             673
               Mississippi           -2          -1         53             283
                 Missouri            -2          0          60             425
                 Montana             -3          -2         69             515
                 Nebraska            -4          -1         79             716
                  Nevada             -1          +1         50             186
              New Hampshire          -3          0          73             808
                New Jersey           -1          +1         63             263
                New Mexico           -3          -1         62             432

                      Percentage point change                           Estimated
                   in the state and other tax     percentage of Estimated average
                           allowance                  students with an EFC dollar
                                                   increase in their increase for
                                                                            those
             State       Families Individuals                EFC with an increase

                                 New York -3 -2 67 639

                              North Carolina -3 -1 68 493

                               North Dakota -4 -1 78 736

                                   Ohio -3 -1 73 589

                                 Oklahoma -2 -1 65 308

                                  Oregon -3 -1 69 519

                                Pennsylvania -3 0 67 713

                                Rhode Island -3 0 60 697

                              South Carolina -4 -2 67 718

                                South Dakota -3 0 64 589

                                 Tennessee -2 0 52 371

                                   Texas -1 0 51 189

                                   Utah -3 -1 73 345

                                  Vermont -3 -1 80 614

                                 Virginia -3 -1 73 623

                                 Washington -2 0 53 429

                               West Virginia -3 -2 68 527

                                 Wisconsin -4 -1 81 802

    Wyoming -2 0 61 408

    Source: GAO analysis.

    Notes: Dependent students whose state of residence is different from that
    of their parents were counted as being from their parents' state. Since
    the EFC for a family is based upon both the parents' and the student's
    income, the EFC changes reported above for each state may reflect not only
    the change in the allowance for that state but also the change for the
    state of residence for students attending school in another state. For
    example, Connecticut, which has an increased allowance, may have families
    with an EFC increase because the children of those families may be
    attending school and residing in another state with a decreased allowance.

    The sampling errors for the average EFC increase for Alaska, Connecticut,
    Delaware, District of Columbia, Hawaii, Idaho, Maine, Montana, Nevada, New
    Mexico, North Dakota, Rhode Island, South Dakota, Vermont, and Wyoming
    vary from slightly over 5 percent (for Maine and New Mexico) to 34 percent
    (for Connecticut). All others have a sampling error at or below 5 percent.

    If Expected Family Contributions Had Increased, Some Aid Applicants Would
    Have Received Lower Pell Grant Awards or Become Ineligible for Them

    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.

    Table 4: Percentage with a Pell Grant Decrease and Average Decrease by
    State, Including Those No Longer Eligible for the Award

                             Percentage         Average    Percentage     Average
                                 with a     dollar             with a      dollar
                            decrease in     decrease in      decrease    decrease
                  State           Pella   Pellb State        in Pella    in Pellb

                            Alabama 38 -111 Montana 48 -174

                             Alaska 28 -83 Nebraska 54 -216

                             Arizona 34 -115 Nevada 25 -80

                         Arkansas 42 -160 New Hampshire 51 -175

                          California 29 -121 New Jersey 26 -90

                          Colorado 47 -156 New Mexico 42 -155

                          Connecticut 0c -100 New York 45 -175

                        Delaware 58 -194 North Carolina 46 -162

    District of 39 -174 North Dakota 48 -229 Columbia

                              Florida 40 -107 Ohio 46 -163

                            Georgia 43 -104 Oklahoma 41 -115

                             Hawaii 47 -216 Oregon 44 -163

                           Idaho 42 -123 Pennsylvania 46 -179

                         Illinois 38 -118 Rhode Island 41 -162

                         Indiana 46 -119 South Carolina 49 -194

                           Iowa 57 -224 South Dakota 41 -176

                             Percentage               Average Percentage  Average
                                   with a              dollar     with a   dollar
                             decrease in          decrease in   decrease decrease
                       State        Pella     Pellb State       in Pella in Pellb
                      Kansas           53   -168 Tennessee            36     -110
                    Kentucky           41     -118 Texas              24      -83
                   Louisiana           35      -113 Utah              47     -148
                       Maine           54    -174 Vermont             49     -161
                    Maryland           46    -112 Virginia            47     -170
               Massachusetts           48     -172 Washington         34     -115
                    Michigan           47  -199 West Virginia         47     -168
                   Minnesota           57   -181 Wisconsin            54     -226
                 Mississippi           35    -120 Wyoming             40     -134
                    Missouri           40   -122 Total USA            38     -144

    Source: GAO analysis.

    aThe sampling errors for Alaska, Delaware, District of Columbia, Vermont,
    and Wyoming vary from 5.2 percentage points (for Delaware) to 5.6
    percentage points (for Alaska). All others are at or below 5 percentage
    points.

    bThe average reflects the reduction for those with a decrease as well as
    those who would have lost eligibility. The sampling errors for Alaska,
    Delaware, District of Columbia, Hawaii, Idaho, Maine, Montana, Nebraska,
    Nevada, North Dakota, New Hampshire, Rhode Island, South Dakota, Vermont,
    and Wyoming vary from slightly over 5 percent (for Nebraska) to 15 percent
    (for Alaska). All others are at or below 5 percent.

    cThe actual figure for Connecticut is 0.1 percent, which rounds to 0
    percent for the purposes of this table.

    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.12 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.

    12High-income families would very rarely have qualified for Pell Grants
    and thus would not have been affected.

    Figure 3: Percentage of Recipients with a Decrease in Pell Award

    100 93.9 96.2

    90

    80

    70

    60

    50

    40

    30

    20

    10

    0 25,000 or less 25,001-50,000 50,001-100,000 Household income (dollars)

    Dependents Independents Source: GAO analysis of the FAFSA applicant file.

    Figure 4: Median Percentage Change in Amount of Pell Award for Those with
    a Decrease

                                          0.0

                                          -2.5

                                          -5.0

                                          -7.5

                                         -10.0

                                         -12.5

                                         -15.0

                                         -17.5

                                         -20.0

                                         -22.5

      -25.0 25,000 or less 25,001-50,000 50,001-100,000 Household income (dollars)

    Dependents Independents

                   Source: GAO analysis of the FAFSA applicant file.

    Note: The sampling error for Independents earning $50,001 to $100,000 is 7
    percentage points. The error for all other categories is 5 percentage
    points or less.

    Changes in EFCs Could Have Affected Stafford and PLUS Loan Awards

    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,13 some students may still have seen a change in their
    subsidized Stafford loan amount.14 Among those currently receiving federal

    13Because some states and institutions do not use the federal EFC to award
    state and institutional aid, a change in the federal EFC may not affect
    the amount of such aid.

    14Subsidized Stafford loan amounts, unlike unsubsidized Stafford and PLUS
    loan amounts, are directly determined by the EFC, subject to an annual
    maximum.

    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.15

    15PLUS loans were not packaged by our case study schools. However, because
    families can borrow up to their EFC (plus any remaining or "unmet" need)
    using PLUS loans and because EFCs typically would have increased under the
    proposed update, we estimate that PLUS loan amounts could have increased
    as well. Furthermore, in cases where a student is already receiving the
    maximum unsubsidized loan amount, PLUS loans could have compensated for
    decreases in other forms of financial aid.

    Figure 5: Percentage of Students Likely to Have Had a Change in Subsidized
    Stafford Loans

                                           50

                                           45

                                          43.1

    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
    needbased 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.

    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

    45.3

                                      >100,000 40

                                           35

                                           30

                                           25

                                           20

                                           15

                                     31.8 31.6 10.9

                                          10 5

        0 25,000 or less 25,001-50,000 50,001-100,000 Household income (dollars)

    Dependents Independents

                        Source: GAO analysis of CEAD STAB data.

    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

    Institutions Have Discretion in Allocating Federal Campus-Based Aid, So
    the Effects of the Proposed Update Would Likely Have Varied

    Work-Study aid would have faced a lower award.16 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.

    Table 5: Estimated Impacts in Campus-Based Aid for Case Study Schools

                                                                   Average dollar
                                                     Percentage with decrease for
                               Form of Campus-Based aid a decrease those affected

    Supplemental Educational Opportunity Grants 11

                                  Work-Study 14 1,200

                                 Perkins Loans 21 1,200

    The Effect of the Proposed Update on State Need-Based Aid Would Have
    Varied Based on State Policies and Changes in the Tax Allowance

    Source: GAO analysis of case study results.

    Note: Dollar figures were rounded to the nearest $100. While an increase
    in EFC may result in decreases in Campus-Based awards for some recipients,
    the amount of such decreases would become available for redistribution to
    others.

    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

    16Three of the four case study schools reported SEOG information, and all
    four schools reported Work-Study and Perkins information.

    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.)

    Table 6: Estimated Impacts in State Need-Based Aid for Two States

    Percentage with a lower amount Average dollar decrease

                                   Wisconsin 53 -115

                                   Tennessee 13 -220

    The Effect of the Proposed Update on Institutional Need-Based Aid Would
    Vary Based on Institutional Policies and Changes in the EFC and Other
    Factors

    Source: GAO analysis of case study results.

    Note: Dollar figures are rounded to the nearest $5.

    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,17 our results show that while more than 20 percent of
    students at each school would have faced a decrease in institutional
    needbased 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

    17The two public schools do not offer need-based institutional aid.

    students at the other school would have seen a decrease of over $425 on
    average.18

    The Current Allowance May Not Capture the Taxes Paid Due to the Type of
    Data and Methodology in Use

    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.

    The Tax Data Used for the Allowance May Not Represent Those Taxes Paid by
    Financial Aid Applicants

    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.19 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.

    18Case studies show that the majority of aid recipients would have seen a
    decrease in their need-based aid equal to or less than their EFC increase.
    However, for about 8 percent of aid recipients, the decrease in need-based
    aid would have been more than 150 percent of their EFC increase.

    19This estimate is made using 2001 SOI data on the percentage of tax
    returns itemized by various income groups and FAFSA Applicant File data on
    the income distribution in 2001 of FAFSA applicants. To make this
    estimate, we assumed that FAFSA applicants within the income groups
    specified by SOI have the same likelihood of itemizing their tax return as
    overall taxpayers do.

    Data Used for the Current Allowance No Longer Include State and Local
    Sales Taxes

    Although sales taxes were included in SOI data when Congress formally
    provided for a tax allowance in the 1986 HEA amendments,20 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.

    SOI Tax Data Are Several Years Older than Reported Income Information

    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.21 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

    201983 SOI tax data was used in establishing the tax allowance when it was
    first incorporated in the HEA amendments.

    21The FAFSA requires applicants to report asset information as of the date
    of the application.

    the agency may be unable to publish the 2003 tax tables because it has
    been experiencing technical problems in processing returns from that
    year.22

    Table 7: Publication Dates of SOI State and Local Tax Data

                     Tax year       Publication date       Elapsed time in months
                         1997              June 2000
                         1998          February 2001
                         1999              July 2001
                         2000             April 2002
                         2001             April 2003
                         2002           October 2004

                Source: Interviews with SOI officials and GAO analysis.

    Education's Calculation of the Allowance Does Not Fully Consider Varying
    Tax Levels Paid by Different Income Groups

    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 more23-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.24 Education's methodology likely

    22According to an SOI official, while SOI has made a commitment to fix
    technical problems with its 2003 master files containing the state and
    other tax data, it is uncertain whether it can provide the level of detail
    needed to update the allowance or when it could release such information.

    23In contrast, the Institutional Methodology (IM) used by the College
    Board has 12 income categories for families, which some experts told us
    allows for more refined estimates of state and other taxes paid by
    financial aid applicants.

    24To determine the allowance for this group, the methodology involves
    taking the sum of the state and other taxes claimed as income tax
    deductions divided by the adjusted gross income (AGI). AGI is the amount
    used in the calculation of an individual's income tax liability and one's
    income after certain adjustments are made, but before standardized and
    itemized deductions and personal exemptions are made. The sum of the taxes
    paid includes taxes such as state and local income taxes, personal
    property taxes, and real estate taxes. For the dependents and independents
    without children, the methodology involves dividing the state and local
    income tax by AGI.

    overestimates the taxes paid by the lower-income group for two reasons.
    First, higher-income individuals generally face higher tax rates than
    lowerincome 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 lowerincome 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.)

    Table 8: Comparison of Income Distribution in 2001 of FAFSA Applicants and
                          Federal Income Tax Itemizers Dollars

                    0.01  10,000 20,000 30,000 50,000 75,000 100,000 150,000 200,000 500,000 million
               0 or    to     to     to     to     to     to      to      to      to      to      or
               Less 9,999 19,999 29,999 49,999 74,999 99,999 149,999 199,999 499,999 999,999    more
    Percentage
     of FAFSA
    applicants 2.51 15.44 16.76  15.50  18.60  13.95    8.40    6.45    1.51    0.81    0.06    0.01
    Percentage
        of
    itemizers  0.76 2.07    5.12   7.85 20.70  24.85  16.27    12.87    4.12    4.25    0.73    0.40

    Sources: GAO analysis of Education's 2002-2003 sample of FAFSA applicants
    and data from the Internal Revenue Service's Statistics of Income
    Division.

    Note: The 12 income groups shown in this table are those used by SOI to
    display state and local tax information.

    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.

    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

    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.

    Use SOI Data with a Revised Methodology

    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.25 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.

    25The income categories established by Congress differ from those
    published by SOI. Congress established income categories of $0 to less
    than $15,000 and $15,000 and above, while SOI data income categories are
    different. Education could have SOI data customized to provide the
    required categories or could use the data on the income groups that best
    match the established categories.

    Replace SOI Data with One of Several Other Datasets

    The second strategy would be to discontinue use of SOI tax data and to
    replace it with publicly available data, such as the following:

    o  	Bureau of Economic Analysis Personal Income and U.S. Census Bureau Tax
    Tables

    o  	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.26 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.27

    o  	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.28 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

    26In the BEA tax tables, household income includes wage and salary
    disbursements,
    supplements to wages and salaries, proprietors' income with inventory
    valuation and
    capital consumption adjustments, rental income of persons with capital
    consumption
    adjustment, personal dividend income, personal interest income, and
    personal current
    transfer receipts, less contributions for government social insurance.

    27 BEA: Methodology-http://www.bea.gov/bea/regional/articles/spi2002
    Reliability
    assessment-http://www.bea.gov/bea/papers/Reliability_SPI_Estimates.PDF.
    Census:
    Methodology-http://www.census.gov/govs/www/statetaxtechdoc2003.html.
    Reliability assessment - none available.

    28These tables are also available on a quarterly basis. However, GAO used
    the annual
    publication to develop the alternative allowances for this report.

    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.

    o  	U.S. Census Bureau-Current Population Survey (CPS)-Annual Social and
    Economic Supplement (ASEC)

    o  	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.

    o  	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.

    o  	Institute on Taxation and Economic Policy (ITEP)-Who Pays? A
    Distributional Analysis of the Tax Systems in All 50 States

    o  	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.

    o  	Use-Were Education to determine ITEP data reliable, Education could
    use the ITEP tax figures to generate tax allowances by income band.29 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.

    Apply a Standard Allowance to All Aid Applicants, Regardless of State of
    Residence

    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.30 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.

    29As explained in appendix I, we were unable to determine the reliability
    of the ITEP data.

    30Education could use any data source, including those discussed above
    that provides household-level information to generate the income and taxes
    paid by the median household.

    Collect Tax Information Directly from Aid Applicants

    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.

    Strategies Would Differ in Terms of Their Effects on Federal Student Aid
    Expenditures and Financial Aid Applicants

    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.31 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 1032 shows the extent to which the tax allowances calculated under
    each strategy would accurately reflect state and local taxes paid by
    students and families.

    31Our estimates on the impacts are limited to changes in the EFC and Pell
    Grant program. We were not able to assess the impact for federal Stafford
    loans and Campus-Based, state, or institutional aid programs. As
    previously mentioned, estimating the impact on federal Stafford loans
    would require data on the extent to which the amount of other forms of aid
    changed as a result of a change in EFC, and such data are not available at
    a national level. Because schools vary in the way they award Campus-Based
    aid, we were similarly unable to assess the potential effects on these
    programs nationally. With respect to state and institutional aid, there is
    no central repository of information on state and institutional awarding
    policies, which prevented us from estimating changes in state and
    institutional aid.

    32As previously discussed, recent legislation providing taxpayers who
    itemize deductions the choice of claiming a state and local tax deduction
    for either sales or income taxes would affect the data collected by SOI.
    Because these effects would be limited to 2 tax years-2004 and 2005-and
    the effects could not be estimated, we did not consider them in our
    comparisons.

    Table 9: Framework for Evaluating Options Identified to Change the State
    and Other Tax Allowance Relative to the Current Allowance in Use

    Proposed Strategy I

    Strategy II Alternative data sources Strategy III Strategy IV

                                                        Proposed 2004-2005 tables

    SOI with revised

    a

    methodology

    BEA / Censusb

    CPS (ASEC)c ITEPd

    Standard

    allowance (4%)e

                                                           Add question to FAFSAf

        Change in federal   - 0.3      + 0.1    + 0.2  - 0.2    + 0.4   - 0.2
              Pell
    Grant expenditureg  billion   billion  billion billion  billion billion  -
          Percentage of
            students
    facing a reduction
               in
        Pell Grant award         38       19       11       32    2       29    -
           Percentage
            retaining
           eligibility           36       19       11       31    2       27    -
         Percentage not
            retaining
    eligibility (number        2       <1       <1        1   <1       2
           of students
           affected)h      (92,000) (26,000) (22,000) (62,000) (1,000) (83,000) -
         Average dollar
             change
    in Pell Grant award
               for
          those with a      - 144      - 103    - 135  - 118    - 90    - 177   -
           decrease i
    Change in expected   + 3.5      + 0.4    - 0.9  + 2.3    - 3.9   + 2.8
             family        billion   billion  billion billion  billion billion  -
          contributionj
          Percentage of
            students
    facing an increase
               in
               EFC               62       38       22       59    4       48    -
         Average dollar
             change
        in EFC for those
             with an
           increase k        493         295      471      338   242     616    -

    Source: GAO analysis.

    Notes: All alternatives are based on what information would have been
    available to Education as of January of 2003 for publication in the May
    2003 Federal Register.

    aThe "SOI with Revised Methodology" figures are based on 2000 SOI data and
    were calculated (by income band) by dividing the aggregate total taxes
    paid deduction by the aggregate adjusted gross income for families and by
    dividing the aggregate state and local income taxes by the aggregate
    adjusted gross income for individuals.

    bThe "BEA/Census" figures are based on 2001 BEA and U.S. Census data and
    were calculated by dividing the sum of property taxes, general sales and
    gross receipts, and individual income taxes from the U.S. Census by
    personal income from the BEA for families and by dividing the sum of
    general sales and gross receipts and individual income taxes from the U.S.
    Census by personal income from the BEA for individuals. Note that BEA and
    U.S. Census data are not provided separately by income band.

    cThe "CPS" figures were generated based on a 3-year average of the median
    effective tax rate, by state, across 1999, 2000, and 2001 CPS data, as
    prescribed by CPS documentation for the study of state-based information
    in the CPS. The median effective tax rate reflects the median across
    households of the sum of state income taxes paid and household property
    taxes divided by total personal income for families and of state income
    taxes paid divided by total personal income for individuals.

    dThe "ITEP" figures are based on ITEP's analysis of tax data and were
    calculated for each income band by summing general sales tax rates, other
    sales and excise tax rates, property tax rates, and personal income tax
    rates for families and by summing general sales tax rates, other sales and
    excise tax rates, and personal income tax rates for individuals. As
    explained in appendix I, we were unable to determine the reliability of
    the ITEP data.

    eThe standard allowance of 4 percent is based on an estimate of the median
    household across states using CPS data.

    fThe impacts of adding a question to the FAFSA could not be estimated.

    gThe estimated expenditure of the Pell Program in award year 2004-2005 is
    about $13 billion under the current allowance.

    hThe sampling errors for those not retaining eligibility for SOI
    (Revised), Census/BEA, and ITEP range from 6 percent (SOI) to 27 percent
    (ITEP). All others have a sampling error of 5 percent or less. Figures for
    the number of students not retaining eligibility are rounded to the
    nearest 1,000.

    iThe estimated average Pell award for award year 2004-2005 is about $2,440
    under the current allowance.

    jThe estimated sum of EFCs across all FAFSA applicants in award year
    2004-2005 is about $75 billion under the current allowance.

    kThe estimated average EFC in award year 2004-2005 is about $6,450 under
    the current allowance.

    Figure 6: Framework for Evaluating the Alternative Datasets Identified
    Relative to SOI Data

                Data quality     BEA/Census       CPS (ASEC)     ITEP     FAFSA
                     Timelinessa                                  b
               Data accuracyc                         d           e
                      Relevancef       g
                Completenessh

    Would improve on SOI data Would not improve on SOI data Would be worse
    than SOI data Undetermined

    Source: GAO analysis

    Notes: The data quality categories are based upon those described in the
    Office of Management and Budget (OMB) guidelines for assessing data
    quality. Please see OMB document "Statistical Policy Working Paper 31 -
    Measuring and Reporting Sources of Error in Surveys."

    aThe assessment of "timeliness" is based on whether Education would be
    able to base its published allowance tables on more recent data than under
    SOI or not.

    bFor years in which ITEP publishes updated tax rates, Education would be
    able to use more recent data in calculating the allowance than SOI data
    would allow, but in other years ITEP data would not yield an advantage
    over SOI data and may in fact be based on data older than what SOI would
    provide.

    Conclusions

    Recommendations for Executive Action

    cThe assessment of "data accuracy" is based on whether the allowance for
    state, local, property, real estate, and other taxes is based on a
    population more representative of financial aid applicants and whether a
    current reliability assessment is available for review.

    dThe CPS property tax data are based on a Census model. Since this model
    has not been assessed for accuracy since 1992, the accuracy of the CPS tax
    data is undetermined. If the data proved to be accurate, then this data
    source would be an improvement compared with SOI data.

    eAs explained in appendix I, we were unable to determine the reliability
    of the ITEP data.

    fThe assessment of "relevance" is based on whether state, local, and sales
    taxes are included in the calculation.

    gBecause property taxes reported by the U.S. Census Bureau are limited and
    because sales taxes include both those paid by individuals and
    corporations, we were unable to determine the relevance of U.S. Census
    Bureau tax data.

    hThe assessment of "completeness" is based on whether data are provided on
    an individual basis and whether the appropriate income bands are
    represented.

    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.

    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

    Agency Comments

    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.

    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.

    Cornelia M. Ashby
    Director, Education, Workforce,

    and Income Security Issues

    Congressional Requesters

    The Honorable Edward M. Kennedy Ranking Minority Member Committee on
    Health, Education,

    Labor, and Pensions United States Senate

    The Honorable Christopher J. Dodd United States Senate

    The Honorable Tom Harkin United States Senate

    The Honorable Barbara A. Mikulski United States Senate

    The Honorable James M. Jeffords United States Senate

    The Honorable Jeff Bingaman United States Senate

    The Honorable Patty Murray United States Senate

    The Honorable Jack Reed United States Senate

    The Honorable Hillary Rodham Clinton United States Senate

    The Honorable Jon S. Corzine United States Senate

    Appendix I: Scope and Methodology

    Overview 	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.

    Datasets 	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

                           Appendix I: Scope and Methodology

    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.

    Estimation Methodology

                                  EFC and Pell Grants

    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.

    Stafford and PLUS Loans 	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.

    Appendix I: Scope and Methodology

    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

    Appendix I: Scope and Methodology

    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.1 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.2

    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

    1This could occur for students whose other financial aid awards do not
    depend on the federal methodology.

    2Our analysis of NPSAS suggests that over 70 percent of subsidized
    Stafford loan borrowers would be eligible to borrow an additional $500 or
    more were it not for the maximum loan cap. Since the average EFC change is
    less than $500, the vast majority of these students would not lose
    eligibility for the maximum under the proposed update.

                           Appendix I: Scope and Methodology

    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.

    State and Institutional Need-Based Aid and Campus-Based Aid

    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,3 (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.

    3We were unable to gain the collaboration of a public institution that
    offers institutional need-based aid in either of these two states.

    Appendix I: Scope and Methodology

    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:

    o  Wisconsin: 7,469,

    o  Tennessee: 8,385,

    o  University of Wisconsin at Madison: 580,

    o  Wisconsin's Marian College: 54,

    o  Middle Tennessee State University: 533, and

    o  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

                           Appendix I: Scope and Methodology

    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.

    Calculation of Estimated Tax Rates from Alternative Data Sources

    Methodology 	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.

                                 Reliability Assessment

    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

                           Appendix I: Scope and Methodology

    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.

    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.

    Sampling Error

    Appendix II: State Selection Matrix-Ranking of Potential Impact of Proposed
    Allowance, Listed by Category

    Estimated

    Percentage of average need-

    Overall average students based aid

    EFC dollar receiving need-amount per Impact State changea based aid
    undergraduate levelb

    Minnesota 542 15.01 4,420 High

    Vermont 489 34.99 1,749 High

    Massachusetts 570 36.22 1,176 High

    Illinois 273 28.93 2,998 High

    Iowa 611 13.97 2,712 High

    Wisconsin 647 27.24 1,098 High

    New Jersey 150 30.73 2,701 High

    Maine 477 32.72 960 High

    Michigan 547 15.26 2,012 High

    Indiana 303 19.84 2,612 High

    South Carolina 484 21.70 1,228 High

    Virginia 456 16.00 1,791 High

    Washington 226 23.14 2,007 High

    Colorado 430 14.32 1,981 High

    California 181 12.55 3,109 High

    West Virginia 357 17.24 1,850 Medium

    Kentucky 224 27.90 1,246 Medium

                 Maryland           345        15.56            1,788 Medium
                 Arkansas           253        19.54            1,736 Medium
              North Carolina        335        12.71            2,065 Medium
                 Delaware           668         2.97            1,370 Medium
                New Mexico          268         9.63            2,436 Medium
                 Nebraska           565        13.09              747 Medium
               New Hampshire        591         8.34              884 Medium
               Rhode Island         418        15.92              706 Medium
                  Kansas            411         7.62            1,466 Medium
                Connecticut         -58        19.21            2,328 Medium
                   Texas             96        13.45            2,190 Medium
               North Dakota         574         7.54              564 Medium
                  Montana           354        16.08              526 Medium
                 Tennessee          194        14.10          1,419 Low
                  Hawaii            509         1.00          1,329 Low
                 Missouri           255         9.09          1,530 Low

    Appendix II: State Selection Matrix-Ranking of Potential Impact of
    Proposed Allowance, Listed by Category

    Estimated

    Percentage of average need-

    Overall average students based aid

    EFC dollar receiving need-amount per Impact State changea based aid
    undergraduate levelb

    Oklahoma 199 15.06 1,168 Low

    Florida 192 15.36 1,074 Low

    Nevada 67 6.50 2,138 Low

                         District of Columbia    291       3.18         1,149 Low
                                         Utah    251       4.70           749 Low
                                      Wyoming    247       1.06           773 Low
                                      Arizona    181       1.49           966 Low
                                      Georgia    258       0.98           667 Low
                                        Idaho    221       3.70           457 Low
                                    Louisiana    254       1.74           501 Low
                                  Mississippi    151       1.52           940 Low
                                      Alabama    184       1.11           577 Low
                                       Alaska    163       0.00             0 N/A
                                     New York    430      49.10         1,968 N/A
                                         Ohio    431      24.96         1,201 N/A
                                       Oregon    359      15.98         1,070 N/A
                                 Pennsylvania    476      32.89         2,331 N/A

    South Dakota 376 0.00 0 N/A

    Sources: EFC Change and Impact Category-GAO analysis of Education's
    2002-2003 aid applicant sample file and the proposed taxallowance.
    Need-Based Aid Information-"National Association of State Student Grant
    and Aid Programs' 33rd Annual Survey Report on State-Sponsored Student
    Financial Aid, 2001-02 Academic Year.

    aThe sampling errors for Alaska, Connecticut, Delaware, District of
    Columbia, Hawaii, Idaho, Maine, Montana, Nevada, New Hampshire, New
    Mexico, North Dakota, Rhode Island, South Dakota, Utah, Vermont, West
    Virginia, and Wyoming vary from slightly over 5 percentage points (for New
    Hampshire, Utah, and West Virginia) to just under 15 percentage points
    (for District of Columbia). All others have sampling errors at or below 5
    percentage points.

    bOnly states that use the HEA federal methodology were given a ranking.
    Thus, the ranking does not apply to the six states listed last.

    Appendix III: Average Tax Rates on Adjusted Gross Income, by State and Income
    Level

    Tax rate by income level (percentage)

    Tax rate by income level (percentage)

                       State   < $20,000    > $20,000 State   < $20,000 > $20,000
                     Alabama           1     3 Montana                2
                      Alaska           2     2 Nebraska               1
                     Arizona           1      4 Nevada                1
                    Arkansas           0    4 New Hampshire           2
                  California           2    7 New Jersey              3
                    Colorado           1    4 New Mexico              1
                 Connecticut           2     6 New York               2
                    Delaware           1   4 North Carolina           1

                     District of Columbia    1         7 North Dakota        0
                                  Florida    1                     2 Ohio    1
                                  Georgia    1                 5 Oklahoma    1
                                   Hawaii    1                   5 Oregon    3
                                    Idaho    1         a5 Other areas        5
                                 Illinois    1         4 Pennsylvania        1
                                  Indiana    1         4 Rhode Island        2
                                     Iowa    1        5 South Carolina       1
                                   Kansas    1         5 South Dakota        0

                            Kentucky 1                      5 Tennessee   0 1
                            Louisiana 0                       2 Texas     1 2
                              Maine 1                         6 Utah      1 5
                            Maryland 2                       7 Vermont    1 5
                          Massachusetts 2                   6 Virginia    1 5
                            Michigan 1                     5 Washington   1 2
                            Minnesota 1                   6 West Virginia 0 3
                           Mississippi 0                    3 Wisconsin   2 7
                            Missouri 1                       4 Wyoming    0 1
           Source: GAO analysis of SOI data for tax year
                               2000.

    Notes: Taxes include state and local income taxes, real estate taxes,
    personal property taxes, and taxes paid to a foreign country or U.S.
    possession.

    a"Other Areas" includes American Samoa, Federal States of Micronesia,
    Guam, Marshall Islands, Northern Marianas, Palau, Puerto Rico, Virgin
    Islands, and other U.S. states and territories.

    Appendix IV: Simulation of Tax Allowance Percentages under Various Options, by
    State-Families with Adjusted Gross Income of $15,000 or More

    Current Proposed Strategy I Strategy II Strategy III

    State

                                Tables published in 1993

    Proposed 2004- 2005 tables

    SOI with revised methodology

    BEA / Census CPS ITEP

                                Standard allowance (4%)

                Alabama             4      2      3      5       3      7
                Alaska              2      1      2      1       1      2
                Arizona             5      3      4      5       4      7
               Arkansas             5      2      4      7       5      8
              California            7      5      7      7       5      8
               Colorado             6      3      4      4       4      7
              Connecticut           5      5      6      6       4      8
               Delaware             7      3      4      4       6      5
         District of Columbia       9      6      7      9       8      8
                Florida             3      1      2      4       1      5
                Georgia             6      4      5      5       5      8
                Hawaii              7      3      5      9      13      8
                 Idaho              6      4      5      6       5      8
               Illinois             5      3      4      5       4      8
                Indiana             5      3      4      5       4      8
                 Iowa               7      3      5      6       7      8
                Kansas              6      3      5      6       4      9
               Kentucky             6      4      5      7       5      8       4
               Louisiana            3      1      2      5       2      7       4
                 Maine              8      5      6      7       6      9       4
               Maryland             8      6      7      5       7      8       4
             Massachusetts          8      5      6      6       7      8       4
               Michigan             8      4      5      6       6      8       4
               Minnesota            8      5      6      7       6      9       4
              Mississippi           4      2      3      7       3      7       4
               Missouri             5      3      4      5       4      8       4
                Montana             7      4      5      5       5      6       4
               Nebraska             7      3      5      5       5      8       4
                Nevada              2      1      2      5       1      4       4
             New Hampshire          6      3      4      3       2      4       4
              New Jersey            7      6      7      5       7      9       4
              New Mexico            5      2      4      7       3      8       4
               New York            10      7      8      6       7      9       4

    Appendix IV: Simulation of Tax Allowance Percentages under Various
    Options, by State-Families with Adjusted Gross Income of $15,000 or More

     Current Proposed Strategy I Strategy II Strategy III Tables published in 1993

    Proposed 2004- 2005 tables

    SOI with revised methodology

    BEA / Census CPS ITEP

                                Standard allowance (4%)

    State

          North Carolina        7        4        6        6        6        8
           North Dakota         5        1        2        5        3        6
               Ohio             7        4        6        5        5        9
             Oklahoma           5        3        4        5        5        9
              Oregon            9        6        7        5        8        9
            Other Areas         3        2        2        5        4        6
           Pennsylvania         6        3        5        5        4        7
           Rhode Island         8        5        7        6        5        9
          South Carolina        7        3        5        6        5        8
           South Dakota         3        0        1        4        2        5
             Tennessee          2        0        1        4        1        5
               Texas            2        1        2        4        1        5
               Utah             7        4        5        7        6        8
              Vermont           7        4        5        8        5        8
             Virginia           7        4        5        5        6        7
            Washington          3        1        2        6        1        6
           West Virginia        5        2        3        7        4        8

    Wisconsin 9 5 7 7 810 4

    Wyoming 2 0 1404 4

    Source: GAO analysis.

    Notes: (1) The CPS tax rates were generated based on a 3-year average of
    1999, 2000, and 2001 CPS data. The standard allowance of 4 percent was
    calculated as the median across states of this three-year average; and (2)
    "Families" are defined to include parents of dependent students and
    independent students with dependents other than a spouse.

    Appendix V: Comments from the Department of Education

    Appendix V: Comments from the Department of Education

    Appendix V: Comments from the Department of Education

    Appendix VI: GAO Contacts and Staff Acknowledgments

    GAO Contacts

    Staff Acknowledgments

    (130308)

    Jeff Appel, Assistant Director (202) 512-9915 Tranchau Nguyen,
    Analyst-in-Charge (202) 512-2660

    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.

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