Magazine | July 29, 2019, Issue

Myths of Student-Loan Debt

Democratic 2020 presidential candidate Elizabeth Warren speaks in Chicago, Ill., June 29, 2019. (Kamil Krzaczynski/Reuters)
The system needs reform, but not all borrowers are victims

There’s a difficult tension at the heart of the debate over how to fund higher education. People who go to college tend to become far richer than those who don’t, and thus it is a handout to the wealthy, or at least the disproportionately wealthy-to-be, to dedicate public money to this end. But there are many students who are qualified for college yet come from families that cannot afford to pay for it. Given this country’s lamentable obsession with the B.A., these kids’ access to the American dream depends heavily on their access to a university.

Our current system, as awful as it is in any number of ways, does far better by poor students than it usually gets credit for — though one might expect liberals to advocate, as always, greater aid for the truly struggling. What they are doing instead is surprising: Elizabeth Warren and other left-wing policy thinkers have offered sweeping proposals to give, under the guise of “student-debt relief,” hundreds of billions of dollars to disproportionately upper-middle-class adults who are done with college and usually did not borrow unreasonable amounts. Warren, for example, would forgive up to $50,000 in debt for every household making up to $100,000, and provide smaller amounts of relief for households earning up to $250,000. Bernie Sanders would do her one better, forgiving all student debt no matter how wealthy the person holding it is. Both candidates further aim to make public colleges “free” going forward, at the cost of hundreds of billions of dollars more over the next ten years. 

These are terrible ideas, for what should be obvious reasons. And when it comes to fixing the way we fund higher ed, there are far better options.

It is important to start with a clear picture of how the current system works: who pays, and how much. While tuition prices have indeed spiraled upward in recent years, largely driven by the administrative costs imposed by an ever-growing campus bureaucracy, several features of that system should stop us from seeing everyone with student-loan debt as a victim.

Sticker shock is the natural reaction to the tens of thousands of dollars that many colleges demand for each year spent on campus. But most students don’t actually pay those prices. Essentially, colleges scrutinize the finances of their students’ parents and then charge each family the most they think they can get away with — this is called “financial aid” — and the sticker price is just the ceiling. Massive taxpayer support undergirds this structure: Public colleges get more revenue from governments than they do from tuition, and even private colleges benefit from federal Pell grants and innumerable tax breaks.

All this combined does make college fairly accessible. On average, according to the College Board, public four-year schools listed their tuition and fees (not including room and board) at $10,230 for the current school year, but students actually paid only $3,740; the comparable numbers for private schools are $35,830 and $14,610. Rich families pay much more than these averages, while poor families pay much less, and sticker prices have grown faster than actual prices have. 

To be sure, some of the tuition rise does fall on people who can’t (immediately) afford it, which is reflected in the fact that students today borrow quite a bit more than their predecessors did. But the higher loan balances are mostly paid off through longer terms, not higher payments, with monthly payments staying reasonably steady as a percentage of borrowers’ household income over the years — and for the typical American household making student-loan payments, this is still less than 5 percent, at least according to the Federal Reserve’s Survey of Consumer Finances. (This is the best source of data on student-loan debt, and virtually all studies of the topic rely on it, but for technical reasons it does not do a great job of capturing the financial situations of many young adults, especially those living with their parents.) By the time they are in the 30–45 age range, according to a recent American Enterprise Institute analysis, college grads in general lose just about 1.4 percent of their income to student-loan payments; this is a considerable increase from a decade ago (when it was less than 1 percent), in part because college grads have become more likely to have postgraduate degrees as well, but it’s hardly a sob story. 

Moreover, college graduates outearn high-school grads — to the tune of seven figures over a lifetime — and for decades have seen stronger wage growth as well. Thus it’s no shock that student debt is skewed toward the rich: The top quarter of households by income have nearly three times as much student debt as the bottom quarter, per the Urban Institute. Further, according to a 2014 Brookings Institution study, “between 1992 and 2010, the average household with student debt saw an increase of about $7,400 in annual income and $18,000 in total debt. In other words, the increase in earnings received over the course of 2.4 years would pay for the increase in debt incurred.” To be clear, high and rising wages for college grads are not an excuse for universities to fail to control their costs. But if college grads’ debts have hardly even nicked their income advantage over the less fortunate, there is little reason to feel especially sorry for them as a group and no reason to start chucking other people’s money at them.

Of course, there are extreme cases. Some students take out big loans for worthless degrees, some borrow for schooling they never finish, and some are outright defrauded. Further, unlike other debt, student loans are generally not dischargeable in bankruptcy. (This is a draconian solution to a legitimate problem: If you get a degree on credit and then drive straight from your graduation ceremony to bankruptcy court, there’s no repossessing the degree.) However, the problem of cripplingly high student debt has already been addressed — at taxpayer expense, and on terms that are overly generous.

Under reforms enacted during the Obama administration, the federal government effectively took over student lending, and it now originates about 90 percent of student loans. (Previously, the government guaranteed loans offered by private lenders, which was not much better from a limited-government standpoint.) There’s some dispute over whether these loans lose the government money or are slightly profitable — it depends which accounting method is used — but by all accounts the terms are more generous than what would be offered in a free, private market, making them a subsidy to college kids.

And students who struggle to pay back their loans have a variety of options. These include deferment or forbearance in times of hardship, having their debt forgiven in exchange for working in “public service” (meaning a government agency or certain nonprofits) while making payments for ten years, and entering “income-based repayment,” under which they pay 10 percent of their discretionary income for 20 years and then any remaining debt is forgiven. Low- and moderate-income borrowers with massive amounts of debt — most common among those who borrow to fund grad school, not two- or four-year degrees — can already wipe out far more than $50,000, as Jason Delisle of the American Enterprise Institute has noted.

Basically, borrowers tend to be wealthy, and non-wealthy borrowers drowning in debt already have options for getting rid of their burden. Thus it’s hardly surprising that forgiving even more debt can easily amount to a handout to the upper middle class. An analysis by the Brookings Institution found that Warren’s plan, despite phasing out benefits for the highest-earning households, would give two-thirds of its benefits to the top 40 percent of households by income.

The plan is especially baffling because it would be both cheaper and more progressive to target debt relief at the most sympathetic cases: former students who bought into the idea that everyone should go to college, took out reasonably sized loans, forked over plenty of their own money to the higher-ed industry, and ultimately proved unable to graduate. According to the industry’s own National Student Clearinghouse, more than 15 percent of exclusively full-time students at four-year public colleges don’t have a diploma — from their starting college or a different one — within six years. And results are much worse for part-time study, for-profit colleges, and two-year degrees: In each of these categories, most students don’t have degrees six years later.

Because so many Americans don’t finish the schooling they start, ending up with some debt but no credential, those who borrow low amounts are the most likely to default. Among those who left school in 2009, for example, nearly a third of those who’d taken out less than $5,000 defaulted by 2014, about twice the rate of those with six-figure debts, according to a study from the Council of Economic Advisers. To the extent these individuals are genuinely unable to pay their loans and lack options under the current system — which is far more beneficial to those with gigantic debts to dump on taxpayers — it would hardly be unreasonable to, say, let them discharge their debts in bankruptcy or even forgive some small debts outright, possibly at the expense of the schools that suckered them.

But that’s tinkering around the edges rather than addressing the system’s real, deep flaws. So let’s return to the paradox outlined at the beginning of this article: We want to make college accessible to everyone with the smarts and drive to graduate, but we don’t want to shovel taxpayer money at the folks in our society who need it the least, which is to say, well, college graduates. We also would like to control rising college costs. And by the way, we already spend so much taxpayer money on higher ed that we could instead give everyone graduating high school somewhere in the ballpark of $45,000 to put toward a long-term investment of his choice, whether that’s college or something else.

Hey, there’s an idea. But here’s a more practical one that’s already gaining some steam: Under an “income-share agreement” (ISA), a student agrees to pay a certain percentage of his income for a certain number of years, and in exchange the lender, sometimes the university itself, pays for his education. If the borrower winds up living in a van down by the river, he pays very little, and if he lands a six-figure salary the instant he graduates, the deal will probably be lucrative for the investor. In particularly bad years the loan is paused, which helps both the borrower (because he’s struggling and can’t afford to lose even a small percentage of his low income) and the lender (because these low-paying years are replaced with higher-paying ones later); and if a student really hits it big, he might hit the repayment cap (say, 2.5 times the amount of the loan) and be done paying early. Currently these agreements typically collect 3 to 15 percent of borrowers’ income for 5 to 15 years, though of course those numbers are malleable to account for different students’ situations.

This solves a lot of problems. Every student with an income-share agreement both has access to college and pays for his own education, regardless of how rich or poor his parents are. There is zero risk that a required payment will exceed even a small fraction of the borrower’s income. Rather than making the same payments continuously, the way most loans work, students gradually pay more as they advance in their careers. Lenders, whether colleges or private third parties, have a strong incentive to choose good students and make sure those students are studying things that will genuinely impart skills and raise their earning potential, because the lenders’ payday depends on the students’ success. In short, ISAs screen out students who won’t profit from college, provide access to those will, and fund higher education with money from the very people who benefit from it, during the years in which they are benefiting. 

I’m a proud extremist: In my ideal world there would be no government funding for higher education, and every college would require every student to fund his education with an ISA rather than taking out traditional loans or winning a grant from the Mommy and Daddy Foundation. (Your love of non-remunerative fields and distaste for parental windfalls may vary.) The worst of American higher education — the money wasted on useless bureaucrats, lavish amenities, and pointless courses of study; the willingness to admit students who need to be retaught half of what they were supposed to learn in high school — would not survive long if every student needed full backing from an investor and also knew he was sacrificing his own future income for every bit of nonsense his school spent money on. Prices would fall dramatically, thanks to reduced waste and demand, though these ISAs would almost certainly have to last longer than the current ones do, to make up for the lack of public funding.

Over in the actual D.C. policy world, the proposals are far more polite. Representatives Mark Green (R., Tenn.) and Vicente Gonzalez (D., Texas) have a bill that would encourage ISAs by streamlining their legal technicalities and improving their treatment under income-tax law. Meanwhile, under a bill put forth by Senator Marco Rubio, students would pay a set “financing fee” (typically 25 percent) rather than interest for their federal loans; borrowers could reduce the fee by paying off their loans early, but the fee would not grow over time as interest does. To stop borrowers from just putting off their payments (so they could pay with future, inflated dollars), Rubio would automatically enroll them in income-based repayment; they would have to put at least 10 percent of their income in excess of $10,000 toward their loans until they paid off the principal and the financing fee. Like an ISA, this setup lets borrowers pay less when they make less and makes it impossible for loan obligations to exceed a reasonable fraction of one’s income, though it lacks many of ISAs’ other advantages. Those who prefer traditional loans could still go that route.

Ideally, an expansion of ISAs — or Rubio’s bill — would be just part of a more general higher-ed-reform platform. Briefly: We need to expand options such as apprenticeships for kids who aren’t cut out for college, and restrict Pell grants to students whose academic credentials make them likely to graduate from the schools they’re attending. As Steven Pearlstein of George Mason University has written, some degrees should take three years instead of four, and schools should operate year-round so that fewer resources go idle in the summer, serving more students in the process. States also need to put their foot down and insist that public schools summarily fire some bureaucrats — I’d start with half, for a nice round number, and see if anyone notices. (But again, I’m an extremist.)

We can make college cheaper, more efficient, and more accessible to those qualified to be there without taking boatloads of taxpayer cash and dumping it into the bank accounts of some of the most fortunate people the world has ever known. Why progressives, of all people, would choose that approach is a mystery.

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