Making Sense of Need-aid and Merit-aid Trends

Several news articles have recently highlighted the move private and public colleges are taking away from need-based aid and toward merit-based aid. What should we make of this trend? Is it a step in the right direction, rewarding students based on achievement? Or does the increase in merit-aid only deepen the divide between high- and low-income families? The question is worth some attention.

What incentives are guiding the shift in financial aid, and who benefits?

People respond to incentives, says economist Steven Lansburg, author of the book The Armchair Economist. This observation is absolutely the case when it comes to the education world. The college ranking system and the government offer various incentives to colleges to influence behavior, and those colleges in turn create incentives that drive the behavior of its students and families. Unfortunately, this system of incentives is an imperfect one, encouraging upper- and middle-income families to engage in a never-ending “arms race” of higher-and-higher GPAs and test scores, and often discouraging lower-income students from attending college at all. Let’s consider a few of these incentives and their consequences.

College rating system:

Currently, colleges and universities are ranked in U.S. News and World Report based on various factors: mission, academic excellence, high school class standing, SAT/ACT performance, student selectivity, graduation rate, peer assessment, retention rates, faculty resources, financial resources, and alumni giving.

  • Based on these factors, colleges are incentivized to seek the brightest students with the highest SAT/ACT scores who are most likely to graduate on time and who are most likely to give back to the school after graduation.
  • Under this ranking system, colleges have little incentive to admit low-income students with generally lower SAT/ACT scores and less opportunity for AP classes.


Obama’s new rating system that he proposed in August would seek to measure colleges based on other factors: college access, affordability, and student outcomes (employment rate, income after graduating, and student debt). Colleges that perform better will receive more financial aid. Colleges lower in the ranking system will receive less financial aid.

  • Colleges are then incentivized to accept students who will be most likely to graduate on time and gain employment quickly after graduating. Kantrowitz in a Forbes article points out that colleges can achieve higher graduation rates by providing grants to middle and high-income families rather than low-income families. A grant of more than 50% carries with it a 63% graduation rate for low-income families, but an 82% graduation rate for middle-income families.
  • Under Obama’s rating system, colleges are still incentivized to target the middle and high income rather than low-income families.


How do these ratings systems influence college behavior? A ProPublica study noted that public colleges and universities are giving less financial aid to low-income students and more to high-income students. From 1996 to 2012, grants to low-income students fell from 34% to 25% for the lowest quartile of income. In contrast, grants to students from families with the highest quartile of income increased from 16% to 23%. Clearly, colleges are responding to the incentives provided them.

  • To gain the revenue needed to attract the best professors, maintain and continue building projects, and keep students happy, colleges are encouraged to accept students who can pay. As noted in the ProPublica study, it serves a college’s interests to provide $3,000 scholarships to four paying students rather than lump that financial aid into a $12,000 scholarship for a needy student.
  • Colleges are further incentivized to admit paying students based on data comparing Pell grants and graduation rates. Kimbrough’s article with Inside HigherEd noted that as the percentage of Pell grant recipients increased, the graduation rates for baccalaureate nonprofit colleges decreased. A college with fewer than 20 percent of its student body comprised of Pell grant recipients had a graduation rate of 79 percent, while colleges with more than 60 percent of its student body made up of Pell grant recipients had graduation rates of only 31 percent.

And these incentives make their way down to students and families. The New York Times noted that college degrees for 24-year-olds from top-income families rose from 40 to 70 percent from 1970 to 2011. Meanwhile, the bottom quartile increased from 6 to 10 percent during that time, hardly an increase compared to the other quartiles.

The current system of financial aid appeals to middle- and upper-income families, but not enough incentives are in place for colleges to reach out in a meaningful way to low-income students.

So what should be done?

Kimbrough suggests that, essentially, colleges should be incentivized to take more low-income students. He likens the college ranking system to a high dive competition. The colleges that currently rank the highest are the ones that perform the “simplest dive,” avoiding low-income students in favor of paying students. He argues that more “points” should be given to colleges that take on Pell grant students and see them graduating at a similar rate as other students.

Unfortunately, we live in a “zero sum” world. Colleges have a limited pool of funds and must invest their financial aid in students who will bring about the most return. More funds allocated for need-based students means less for merit-based students. Less scholarship means that middle- and high-income students will go looking elsewhere, and the college that doesn’t “play along” by admitting more Pell grant students may still reach its financial goals sooner than colleges that seek to attract to low-income students. Unless the government provides significant incentives for colleges to admit more Pell grant students, merit-aid will continue to be the modus operendi for most colleges and universities.

Does that mean that merit-aid encourages an unfair system?

In these discussions, it’s very easy to separate high school students into two groups: those who need financial aid and those who don’t. The truth is that we are dealing with a spectrum of need, which makes labels of “fair” and “unfair” inappropriate. For many middle-income families, a $5,000 scholarship can open up opportunities that wouldn’t be available without that aid. There is a sense in which colleges should be attracting students based on high school performance and test scores (which are a moderate indicator of college readiness), and merit-aid can help draw those college ready students. At the same time, “need” for merit-aid students can look vastly different than “need” for need-aid students. In the first case, missing out on a scholarship can limit the potential pool of schools; in the second, it can remove all opportunity for higher education.

What does this mean for me?

Whether we agree with the trend or not, merit-aid makes sense for a college’s balance sheet. Although the SAT shows strong correlation with family income, the SAT/ACT tests remain higher education’s metric by which to measure college readiness. As long as the current system incentivizes colleges to attract students who can pay and who can also demonstrate that they can handle college-level courses, merit-aid is here to stay.


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