Income-Tested College Financial Aid and Labor Disincentives

Working has become commonplace among college students; however, this activity can have unexpected financial consequences. Federal formulas implicitly tax the amount of financial aid students are eligible to receive by as much as 50 cents for each marginal dollar of income. This tax creates an incentive for college students to reduce income, though abstruse formulas and the timing of financial aid receipt are likely to limit responses. Using data from a national sample of financially independent college students in the United States, I do not find that students bunch below earnings protection thresholds in a manner that would indicate attempts to avoid reductions in financial aid in total or grants specifically. Moreover, I do not find evidence that implicit income taxes predict lower earnings in a manner that suggests that students meaningfully reduce earnings in response to the tax. Therefore, while economically efficient, the reduction in aid has the potential to burden low-income students who need to both work and receive financial aid in order to afford college expenses.