Investors, not students, should bear the vast upfront costs of US tuition

Selling income-contingent stakes in the future earnings of graduates is the best way to address the student debt crisis, says Paul Oslington

June 23, 2020
Students, graduates and activists rally at Union Square in NYC against banks exploiting students with loans for education
Source: Alamy (edited)

The US has a problem with student debt. Not just the record $1.6 trillion (£1.4 trillion) owed by graduates, but also the fact that much of this sum was accumulated on degree programmes that offer individuals little chance of earning enough to repay their loans.

One thought is that the solution could be a version of Australia’s income-contingent loan model – which has been copied by the UK and New Zealand – whereby graduates begin to pay their college debt, via the tax system, only when earning above a certain threshold. This has the equity advantage of removing the upfront cost barrier to study and removing the millstone of college debt from around the necks of low earners. The problem is that it also heightens the perverse incentive for colleges to recruit those who are ill-equipped to benefit from higher education.

At its worst, Australia has seen dodgy institutions – aided by agents on lucrative commission – enrol almost anyone in order to enrich themselves via the initial payment from the government. Free laptops and other inducements were used, with old people’s care homes and remote Indigenous settlements among the markets targeted. Students were enrolled in completely unsuitable courses, and many never turned up to class. Huge debts were run up that were never going to be repaid, and concern about Australia’s student debt, now standing at about $70 billion, has led the government to reintroduce student number controls.

Could such a system fly in the US? In a word, no. As in Australia, those unsuited to college would be recruited. Moreover, unlike in Australia (where 90 per cent of students are enrolled in public universities charging regulated fees to domestic entrants), the US has a diverse system of public and private institutions, which charge wildly different amounts. In this unregulated landscape, income-contingent loans would cause fees to spike dramatically because students are less price-sensitive when fees are paid at an uncertain future time.

That risk posed by rapacious college administrators would not be mitigated by penalising colleges with poor records on dropout rates and graduate earnings. By the time dubious enrolments were exposed in this way, the shady college administrator behind the lax standards and unsuitable courses would most likely have moved on. Introducing Australian-style regulation to weed out unscrupulous practice is also a non-starter. Federal involvement in higher education is viewed with much greater suspicion across the US sector, from the Ivy League to specialist Christian colleges.

Indeed, Americans are much warier than Australians of governmental action in general. Australians generally support government involvement in student loans, just as they support government-provided universal healthcare and a social safety net. Even if the experience of other countries disproves the argument that such schemes are a slippery slope to communist dictatorship, a scheme that exposed US taxpayers to additional costs and risk would probably be politically impossible.

Instead, the US should modify the Australian scheme by cutting out the government as a risk-bearing middleman. Colleges should create their own bonds, via which investors could purchase an income-contingent stake in the future earnings of their graduates, rather than government or the student paying up front for their tuition.

The government would still, for fairness reasons, set the rules of this sort of income-contingent loan scheme, specifying repayment thresholds and indexation rates on the bonds (perhaps in relation to some market benchmark). It would also collect debt repayments via the income tax system and pass them on to the bondholders. And it could, if it saw fit, provide extra funding for courses with public benefits in excess of the private return to the student, such as nursing, teaching or foreign languages. However, the government would not offer any guarantee on the student debt, and colleges would remain free to set their fees and enrol as many students as they liked.

The student debt bonds would be sold on the open market, and actuaries would price them based on the likely future incomes of the college’s graduates. Data on the incomes of graduates of different programmes at different colleges are readily available, and the bond prices would give an immediate signal of the worth of different programmes and colleges, causing shady administrators to think twice about reducing the value of degrees by boosting enrolments and pass rates.

A low bond price would also be a much-needed wake-up call for conscientious college administrators – and, since it would be public, it would also be a powerful warning sign to students thinking of applying to that college.

A small number of US universities have recently been experimenting with similar schemes, whereby their students promise to share some of their post-graduation earnings with their college or private investors. But the details of the arrangements make a big difference, and there are dangers. For instance, without the crucial ingredient of financial markets pricing the debt, and the revenue for the university being that price, administrators still have the incentive to enrol and pass students who will not benefit.

My proposal removes that incentive and is more politically realistic than making university study free, capping tuition fees or introducing a national income-contingent loan scheme. I hope it receives serious consideration.

Paul Oslington is professor of economics and theology at Alphacrucis College in Sydney, Australia and former vice-president of the Economic Society of Australia (NSW). He is on sabbatical at the Center for Theological Inquiry in Princeton, New Jersey.

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