• What if colleges were at risk for costs?

    The following appears on page 81 of Equality and Efficiency: The Big Tradeoff, by Arthur Okun, written in 1975.

    In a financing plan now experimentally used at Yale, the student is offered loans with an obligation to repay that is fixed not in dollars but rather as a fraction of his or her future income. If the borrow’s lifetime income turns out to be very high, the loan will be, in a sense, overpaid, but it will not prove burdensome; moreover, some of the good fortune can be attributed to the benefits of education. On the other hand, the person who does not earn much has no onerous commitment. For society, this concept could be incorporated in a voluntary social insurance plan that would operate in reverse sequence to the present old-age program. Young people get the money first and pay back later, with the repayment levied as a supplementary tax on income.

    I wonder what happened to that Yale program. Are any institutions offering loans of this type? It certainly gives the institution a big incentive to help students land well-paid jobs and achieve lucrative careers. That’s not such a bad thing for the student either.

    Recognize that there are a lot of possible variations here. What percent of the tuition is tied to future earnings? What percent of future earnings are earmarked for the institution and over what duration? By adjusting these variables, one can achieve different allocations of the cost risk of college between the student and the institution, with correspondingly different incentives for each.

    Naturally, if the college is at risk, providing all the up-front costs and expecting a return from future earnings, a student could “take advantage” and get a free education. But to do so the student impoverishes himself. Over a large enough risk pool of students, a few deadbeats would be balanced by high earners. Given the other benefits of high incomes, this seems doable.

    One concern would be the student from a wealthy family with a trust fund. Perhaps that family could arrange a free education. If the student never works, the loan would never be repaid. Perhaps loans of this type should only be available to students demonstrating inability to pay up front (i.e., the family has to fulfill a minimum contribution related to its income and assets).

    But these are all details. In broad stroke, are ideas like this part of the future of paying for college? Why or why not? If such loans do not now exist, why isn’t the financial industry offering them?

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    • I have an 18 month old daughter. We are using our tax refund to fund her 529 plan for this year. I personally think that this is a good idea for college payment plans.

      My college loan is by no means expensive. It’s more of an annoyance to me at this point, and I got a whopping $500 off my AGI thanks to student interest deduction this year.

      I feel that higher education will be the next bubble to burst. We are living in a time where it’s almost impossible to get a non-vocational job without a bachelors degree, yet the cost rises well above inflation each year – then you add on fees, room & board, books etc. It’s unsustainable. Something will have to give – at least that’s what I keep telling myself. In the meantime I have 17 years to save as much as I can for my daughter.

    • Yale Law School actually has a very similar program in place. The law school reimburses you for a significant fraction of your loan repayment costs based on your income. Details here:

      They frame the program very differently – it gives graduates the freedom to accept lower paying public interest jobs rather than higher paying corporate law jobs.

      • @Jessica B – There are likely things that have some similarities, like capping the repayment rate based on income. The key here is giving the school a stake in future earnings, so it could be overpaid if graduates earn more then expected. It’s a risk transfer. That’s what’s interesting.

    • Many law schools have some variation on this scheme. There is a real risk that, burdened by high debts, law graduates would be forced to choose high-paying jobs (big firms, corporation), and there would be none able to take on public-service or NGO positions. In response, many law schools offer some kind of “loan forgiveness” program to those who have low incomes post graduations. A common approach is to limit student-loan payments to a percentage of income, and then forgive any remaining balance after a period, perhaps 10 years.

    • “I wonder what happened to that Yale program. Are any institutions offering loans of this type? It certainly gives the institution a big incentive to help students land well-paid jobs and achieve lucrative careers. That’s not such a bad thing for the student either.”

      The original program at least was a disaster, I do not know about the current law school program. But, the original was an unmitigated disaster. Too many people, especially those who had the very high incomes, either legally defaulted on the loans or simply refused to repay them (one the reasons modern student loans are basically impossible to default on). However, the idea of income-contingent loans (a product of none other than Milton Friedman) are the basis for the high education financing system in a handful of countries, most notably Australia.

      Chapman 2006, “Income Contingent Loans for Higher Education” would be the rest academic reference I know of if you want to learn more.

      UPDATED by Austin: Ungated link to the Chapman paper: .

    • The plan didn’t work due to the high default rate. I remember reading an article or blog post about this in the last year or two, but couldn’t find it.

      http://www.nytimes.com/1999/04/13/nyregion/yale-to-erase-alumni-debts-in-2-loan-plans.html?ref=yaleuniversity

    • Law school loan forgiveness requires you to work in the public sector in order to qualify. The folks who don’t get a public sector job are still screwed if they are underpaid, and that’s still a lot of people.

    • Interestingly enough there’s a fictional book that has a plot very similar to this idea. “The UnIncorporated Man”, I came across it in a Marginal Revolution post.

      http://www.marginalrevolution.com/marginalrevolution/2009/11/the-unincorporated-man-and-slavery.html

      Definitely an interesting read.