The cost of higher education has exploded while its value has increased. Your lifetime earnings could be 84% higher if you graduate from college. This leaves many young people debt-wracked.
In America, the percentage of households, headed by under-35 year olds, with education debt increased from 17% to more than 40% between in 1989 and 2010. The figure below shows their average debt:
One lifeline, which has been common in Europe for years and recently expanded in America, is fixing loan repayments to income. Under the new American program your loan repayments won’t exceed 10% of your discretionary income. Whatever balance is left after 20 years is forgiven, which means that the price you pay for your degree is based on what you earn from it.
Fixing the cost of education to income is nothing new in the US. American universities already practice price discrimination: They get detailed financial records from the families of each student and set a price based on parents’ income and wealth. But the income-based loan program is different because the loan is guaranteed by the government. So rather than universities subsiding low-income students, the taxpayer does.
This program gives students an incentive to take out as much debt as possible, if they anticipate a low-earning career where the debt will be forgiven, why not? It also imposes a new marginal tax on people with student debt. The program also seems to favor people who end up a high earner, once you qualify for income-based payments you stay in the program, no matter what your income is in the future. So presumably, you can graduate college with lots of debt, become a ski instructor for a few years before starting your career at a hedge fund and qualify for large subsidy from tax-payers.
Also, it’s not clear what the economic reasoning is behind this program. The primary rational is to relieve debt-burdened students in the short-term and not let the high cost of university discourage people from going. Education is a great equalizer, which is why basing tuition on parental income makes sense. But why should the government subsidize a low-income career path? True, new graduates are facing a tough job market and it may take decades for their income to recover. But that might warrant fixing payments with age or offering debt relief during recessions.
An economic justification for an income-loan repayment program requires showing that most poorly paid jobs bestow a positive externality to the rest of the economy and that they are not attracting adequate talent. That’s probably true for some jobs, like teachers or doctors in underserved areas, but all low-paying jobs? Sometimes a job doesn’t pay well because the wage reflects its economic and social value. Other jobs, like journalism, don’t pay well but still attract many talented graduates. Is there a reason why taxpayers should subsidize this career choice?
A post-secondary education is becoming necessary for a middle class lifestyle. Some reckon it’s becoming a bubble where people spend years studying for degrees they don’t use or drop out before they graduate, laden with debt they can’t repay. The question is whether income-based loan repayment addresses these problems? The motivation to earn money after graduation gives people an incentive to study subjects that give them useful job skills.
It could be argued that many people drop out because they are put off by the amount of debt they’re accruing and worry they won’t be able to pay it off. The drop-out issue is a big problem, but evidence suggests people drop-out because of a lack of emotional and institutional support and adequate secondary school preparation rather than lack of funds. It seems addressing those issues directly would be a better use of tax-payer resources.