Paying It Forward: A Different Take on Income-Based Repayment

In prior blog posts, I have been less than charitable toward the federal government’s changes to the income-based repayment policies for student loans. (As a reminder, these changes provide large subsidies to students who attend expensive colleges and particularly those who earn good salaries after having attended law or medical school.) My criticism of the federal government’s way of implementing the program does not mean that I am not open to a better way of income-based repayment. With this in mind, I look at a proposal from the Economic Opportunity Institute, a liberal think tank from Washington State, which suggests an income-based repayment program for students attending that state’s public colleges and universities.

The EOI’s proposal, called “Pay It Forward,” would charge students no tuition or fees upfront and would require students to sign a contract stating that they would pay a certain percentage of their adjusted gross income per year (possibly one percent per year in college) for 25 years after leaving college. It appears that the state would rely on the IRS to enforce payment in order to capture part of the earnings of those who leave the state of Washington. This would be tricky to enforce in theory, given the IRS’s general reticence to step into state-level policies.

I am by no means convinced by the group’s crude simulations regarding the feasibility of the program. This is currently short on details and would also require a large one-time investment to get off the ground and enroll an initial cohort of students. Additionally, it is not clear whether the authors of the report accounted for part-time enrollment patterns in their cost estimates. I also urge caution with this program, as this sort of an income-based repayment program decouples the cost of attendance from what students actually pay. Colleges suddenly have a strong incentive to raise their posted tuition substantially in order to capture this additional revenue.

With all of these caveats, the Pay It Forward program does have the potential to serve as a simple income-based repayment program once analysts do more cost-effectiveness analyses. But this will only work if policymakers keep a close eye on the cost of college in order to result in a revenue-neutral program. My gut feeling is that the group’s estimates understate the cost of college under current rules and don’t consider the possibility of the incentives that will increase cost.

A November Surprise in Student Loans

A few weeks ago, I co-authored a piece in The Chronicle of Higher Education on the federal government’s authority to relax income-based repayment requirements for student loans. To summarize the proposal, the federal government was granted the authority (starting in 2014) to allow students to repay student loans using only ten percent of their discretionary income for 20 years, down from 15 percent for 25 years. Our argument in the Chronicle piece is that the program represents an enormous subsidy for students attending expensive colleges and particularly professional schools. We were not the only people with those concerns; the left-leaning New America Foundation put out a similar set of concerns.

I was very surprised to learn yesterday that the Obama Administration published the final regulations for the new income-based repayment program (called “Pay as You Earn” or PAYE) in the Federal Register, which will suddenly take effect much sooner than 2014 and apparently no later than July 1, 2013. There appears to be no regulatory authority for speeding up the changes, other than the federal requirement that regulations be published by November 1 in order to take effect on July 1 of the following year. These regulations continue a disturbing trend of this administration ignoring Congressionally mandated timelines. It is my sincere hope that someone will ask the Department of Education for clarification as to how speeding up implementation is legal, especially when Congress did not agree to that timeline and there is a cost impact (more on that later).

Substantial legal issues aside, it appears that the Department of Education did not seriously consider the moral hazard concerns of people taking out more debt simply because they will not have to repay it. Buried on page 28 of the 61-page regulation document is the following nugget:

“Income-based repayment options may encourage higher borrowing and potentially introduce an unintended moral hazard, especially for borrowers enrolled at schools with high tuitions and with low expected income streams. Some commenters disagreed with the inclusion of this moral hazard statement, noting that the aspect of more generous income-based repayment plans causing increased borrowing has not been established. The Department has not found any definitive studies on the matter but since some analysts, academics, and others have suggested the possibility of this inducement effect, we wanted to address it to ensure comprehensive coverage of this issue.”

The Department of Education then never addresses the topic in the rest of the regulation document, instead focusing on the benefits for borrowers with more modest amounts of debt and household incomes of less than $60,000 per year. I side with Jason Delisle and the New America policy folks, who still note that moral hazard is a substantial concern.

The cost estimates seem way too good to be true, which is often the case in implementing new federal programs. The Department of Education (on p. 35 of the regulations) estimates that the cost will be only $2.1 billion over the next ten years, which seems to be an incredibly low number. Assuming roughly $250 million per year in additional costs over the peak years of the budget window (the last few years should not be included because they don’t include the full cohort costs) only covers $50,000 in loan forgiveness for 5,000 students. There are a lot more than 5,000 law and medical school graduates who could benefit under this program, yet it is unclear whether the Department of Education actually modeled professional school students (they mention on page 34 that graduate students were modeled, but they have much less debt on average).

Despite this change being a substantial shift in student loan policy, the education community and the media don’t seem to be too interested in the substantial cost shifting. The Chronicle had a nice article (subscription required) on the moral hazard regarding the program and Inside Higher Ed mentioned the release of the final rules, but completely missed the point. The conservative Daily Caller also mentioned the changes, but doesn’t get into the questionable legal foundation of advancing the policy before 2014 or the issue of who benefits.

It is easy to link the release of these regulations to electoral politics as usual, and I am certainly skeptical of what happens this time of year. However, given the lack of media coverage and the fact that it all hasn’t been positive, it appears that the Department of Education wanted to release the rules to have them take effect before receiving more public scrutiny. Hopefully, there will be a successful lawsuit delaying the rules on the grounds of the Obama Administration overstepping its legal authority to have the rules take effect in 2013 instead of 2014—and this will give researchers and policymakers a chance to rewrite the rules to target aid to those who truly need it instead of subsidizing expensive professional education programs.

Improving Income-Based Repayment

As regular readers of this blog know, I am keenly interested in exploring the cost-effectiveness of policies affecting the world of education. This week, the New America Foundation released a report detailing changes made by Congress and the Obama Administration to income-based repayment. Income-based repayment allows people to pay back their student loans by paying a fixed percentage of their income over a long period of time; this differs from traditional loan payments in the sense that loan payments can do down if income is low and up if income is high.

The recent actions of the good folks in Washington resulted in a system that substantially reduces the payments for people who take on a lot of debt (generally those who attend very expensive colleges or get professional degrees). Giving heavy subsidies to high-income, well-educated people isn’t the most cost-effective strategy and encourages the cost of higher education to rise even higher.

I combined with Sara Goldrick-Rab, my friendly neighborhood dissertation chair and someone who occupies a distinctly different political space from me, to write a piece for The Chronicle of Higher Education on how to improve income-based repayment. Take a read and let me know what you think. The New America people are certainly interested in considering changes to their proposal, and so am I.

As an aside, it always feels nice to get some publicity for your thoughts, especially while navigating the job market. Stay tuned for my next endeavor…coming soon!