Student Loans and the Revolution in College Financing

Kevin Carey provides a compelling argument to support his contention that federal student loan programs have transitioned to a more student-friendly form that should be recognized as a federal supplement to the traditional state support of public college education.  His discussion appeared in the New York Times under the title A Quiet Revolution in Helping Lift the Burden of Student Debt.

The federal government began issuing loans to students through commercial banks in the 1960s.  While the government provided subsidies to the banks to try to keep costs low, the banks had a good deal of discretion in the terms of repayment.  The banks also insisted that these student loans they disbursed could never be settled in a bankruptcy.  Over the years, the government has made changes in policy aimed at providing more generous options for students needing loans.  Finally, in 2010 the Obama administration terminated the support of bank-issued loans.

“In the 1990s, President Clinton helped create a new loan option that allowed students to borrow directly from the United States Department of Education. If they did, they were eligible for an income-based repayment regime in which loan payments were limited to 20 percent of the borrower’s income, after a deduction for basic living expenses. Any balance remaining after 25 years of payments was forgiven.”

This program was little known and little utilized at the time.  Further changes arrived in 2007 under the Bush administration when the Clinton program was modified to make it even more student-friendly.

“The 2007 law modified that idea and called it IBR (for Income-Based Repayment). Under the new program, the repayment terms were made more generous. Monthly payments were capped at 15 percent of income, rather than 20 percent, and the living expense deduction was raised significantly. The loan forgiveness threshold stayed at 25 years, with an important exception: Loan balances would be wiped clean after only 10 years for people who worked in public service jobs, broadly defined as anywhere in the government or nonprofit sectors.”

In 2010, under Obama, government subsidy of bank-issued loans was terminated and new regulations were put in effect.

“Important changes to the income-based repayments were made, but because they were passed under the same legislation that created the Affordable Care Act, few people paid much attention to them. IBR had been made even more generous. Now borrowers had to pay only 10 percent of their income per month, even as the forgiveness threshold was lowered to 20 years. People who work in government or nonprofits are still eligible for forgiveness after a decade. Although it was originally slated to become effective in 2014, Obama administration lawyers found a way to effectively speed up the IBR start date by several years. Most important, all students would now borrow directly from the federal government and be eligible for the more favorable repayment terms.”

Public college education has always been subsidized by taxes in order to keep tuition costs low so that that access would be available to as many people as possible.  Attendance at a public college was implicitly considered to be a right for all qualified students.  In recent decades college access has been threatened as state budgets have been unable to keep up with costs and legislatures have been unable or unwilling to raise taxes.  Some governors have been explicit in referring to advanced education as not a right but a privilege—a privilege that one should be willing to pay for.

Carey argues that students have always paid for this privilege.  Students who went to college earned more money and paid more taxes in their lifetime, thus returning the favor—perhaps many times over.  Carey sees the current income based repayment plan as a mechanism by which the federal government is assuming some of the role of states in maintaining affordable public higher education.

“The historical social contract used to be straightforward. All citizens were eligible for generous government college subsidies in the form of low tuition at public colleges and universities. Graduates ‘paid back’ that subsidy in the form of larger tax payments — and in most states, higher marginal tax rates — on the additional income that their diplomas helped them earn.”

“By moving more students into IBR, the federal government is essentially replicating this arrangement. Once again, those who earn more pay more, returning the full amount of their loan, plus interest, before the 20-year forgiveness threshold is met. Those who earn less, for whatever reason, pay less. Nobody will ever default simply because they can’t afford to pay.”

Carey also indicates that the recent Obama proposal to provide students with two years of free community college education is an additional move in this same direction.  The federal government will again provide a subsidy for state higher education.

The IBR approach is a much fairer approach for students.  It has essentially converted a loan program into an income-based tax of 10%.  The tax at 10% is much less burdensome than traditional loan repayment, and the forgiveness period allows those with low incomes to eventually escape from the levy.

Unfortunately, most of those burdened by student debt are frozen into the terms of earlier loans.  There is also a certain moral hazard involved.  The federal government is inviting state governments to relinquish some of their former funding responsibilities by lowering education funding or raising tuition on the assumption that the feds will make up the difference.

Carey provides this conclusion:

“In the long run, the signs point toward the federal government replacing states as the primary financier of American higher education. Given how much unnecessary financial hardship has been imposed on students, this is a welcome trend. The sense of pervasive student loan anxiety that characterizes much of the contemporary higher education conversation could become a relic of an older time.”

It is sad that we must resort to such indirect means to assist students who wish to attend a college.  Why can’t we just agree to pay for the things we need to do?