Alex Holt, a program associate with the Education Policy Program at the New America Foundation, has kindly agreed to share his thoughts on Oregon’s new “Pay It Forward” initiative.
A few weeks ago the Oregon state legislature directed a relatively obscure state education panel to consider creating a pilot program on a relatively obscure student loan repayment scheme that was pitched by a group of college students from Portland State University. No groundbreaking news there. Except something unexpected happened: the Wall Street Journal and New York Times both picked up the story, with the Times going a step further and assembling a team of education experts to weigh in on the proposal. That propelled the policy idea into the national media, and the higher education policy world has been debating it ever since.
So are the students at Portland State University onto something big, or were the Times and the Journal duped?
The catchy title “Pay It Forward, Pay It Back,” admittedly suggests something big, as does the elevator pitch. Eliminate tuition and fees entirely at Oregon universities and instead charge graduates 3 percent of their incomes for a period of 24 years after they leave school. That means payments are more equitable because they are based on after-school earnings not family income when a student attends school, and graduates without the ability to pay simply won’t have to. As if that wasn’t enough, the program will purportedly pay for itself.
Despite the snappy name and the slick elevator pitch, there are three big problems that the state education panel will have to confront to implement this type of program.
The first is adverse selection. If the plan is meant to pay for itself over time, high income graduates must pay more to offset the low payments from graduates earning little income. While that seems obvious, few people realize that also means high income graduates would probably have to pay more than they would under existing student loan options. That creates an incentive for students undertaking high value degrees, like computer science majors, to opt out of a program like ‘Pay It Forward’, and to go the traditional loan route. Oregon is then stuck funding low-return educational investments and is unable to recoup the costs of the program. And forget about the state charging different degree seekers different rates in order to avoid adverse selection. The political backlash that will occur once Oregonians realize social workers and teachers have to pay 10 percent of their incomes while engineers pay 2 percent will likely sink the program.
Second is the difficulty of collecting the incomes of graduates living outside Oregon. The state only has taxing power within its borders, which means that students who leave Oregon may get away with not paying. Creating an incentive for students to leave Oregon is obviously not the intent of the policy, and there are possibly ways for the state to either get the federal government to help out, or to hire collection agencies to hunt down offenders. Those may nevertheless be prohibitively burdensome and costly.
Third, up until now the discussion about costs has been naïve. For instance, some commentators have even suggested that the policy would make money for Oregon. Those arguments have largely been based on analysis from the Oregon Center for Public Policy (OCPP), which calculates that the average student opting into the policy would pay $7,000 more than their original $32,000 tuition expenses, though the analysis ignores the time-value of money in that calculation.
This argument is misguided because it is not a comprehensive accounting of the costs. Oregon has to pay the cost of running a university system now, but the students would pay those costs slowly over 24 years. To bridge that gap the state must borrow in the credit markets by selling bonds that pay interest.
Assume investors would demand five percent interest for a revenue bond backed by the student payments over 24 years. Now the state is on the hook for the $32,000 tuition for any given student, since I’m sure professors are unwilling to work for free. So the state has just taken out a massive loan to fund tuition, and that means that in order for the policy to pay for itself, students must effectively break even on paying back a $32,000 loan at 5 percent over the course of 24 years. The student makes less money at the beginning, which means that the interest is piling up on the loan balance. If we treat this as an income-contingent loan for the student, where they pay back a percentage of their income while interest accrues, the OCPP data actually shows that Oregon students would, collectively, never pay back their loans, and in fact would never even make a principal payment on them. In fact, the typical Oregon student would receive an equivalent of $36,205 in loan forgiveness at the end of their 24th year. But the state’s bondholders wouldn’t forgive the debt, of course, so taxpayers would have to fund the difference.
And that is the irony in the Oregon plan – it doesn’t eliminate debt. Someone still has to borrow if Oregon wants to pay university faculty today with some future stream of payments, it just happens to be the state.
‘Pay It Forward’ is a dangerous, half-baked idea, and as Dylan Matthews argues at the end of his thorough analysis of the program, changing the existing loan program to automatically enroll students in Income-Based Repayment is a better idea:
“If you like the idea of payment based on income, but don’t want people to pay more than their education actually cost, and want a system enforced by an institution that both has a lot of experience running this kind of thing and can print its own money, the Petri-Polis bill [which would automatically enroll all students into Income-Based Repayment] is probably a better bet than what’s being tried in Oregon.”
He’s right—automatically enrolling students in IBR is infinitely better than trying to scale the Oregon program. But that actually makes this situation even more tragic, because funding students through an equity finance arrangement, as opposed to having students take out loans, is, in principle, a great idea. Students would bear no upfront risk and investors could be compensated well for students who go on to make good salaries. This system would have the added benefit of signaling the relative value of different institutions or programs to students based on the difference in the percentage of their income the student would have to pay back. This makes equity financing a fundamentally better option than income-based repayment because it signals economic value to the student and provides an upside to the investor. However, this investment risk should be borne by private investors, not by the state.
Oregon, on the other hand, has proposed creating a graduate tax with a rate that would either be so low that it would cost the state money or so high that all of the “good investments” would opt-out, and, again, cost the state money. There may be a happy medium, but it seems like a tall order for a government panel to find it.