Susan Walsh/AP Photo
President Joe Biden answers questions with Education Secretary Miguel Cardona about student debt relief, in the South Court Auditorium on the White House complex, October 17, 2022.
New rules proposed on Tuesday by the Department of Education that would make the income-driven repayment (IDR) system more generous would effectively put an end to student loans, at least as we commonly understand them. As long as IDR is well publicized, affording a college degree will now be a matter of handing over a set percentage of future earnings for a set amount of time. But while this changes the situation for students, it does not end the debate over the optimal way to finance higher education.
The popular conception of a student loan, or any loan, is that you take out a sum of money from a lender—in this case, the Department of Education—with a promise to pay the principal back over a certain time frame, with interest. This was always a strange fit with the student loan program for a variety of reasons. First, there is no assessment of creditworthiness on the front end. Second, because the federal government has a host of ways to get repaid (garnishing wages, appropriating tax refunds, even debiting Social Security payments), there is essentially no risk to the government of default or lack of payment, which should affect the interest rate—downwards. Third, student loans do not require repayment while in school, but on some loans, the interest that accrues during that time gets capitalized into the overall balance, routinely increasing the principal of the loan. For this and other reasons, the numbers thrown out about student loans are essentially drawn up out of thin air.
Under income-driven repayment, all of the nuts and bolts of loans can be ignored. The borrower will pay a percentage of their income over a certain threshold for a set number of years, and then the obligation will be met. Notions of a “principal balance” or “interest” or anything else will be immaterial when the amount due is just based on what you earn.
The previous IDR system for undergraduate loans required borrowers who make more than $20,400 per year to make payments, which were capped at 10 percent of discretionary income. That would last for between 20 and 25 years, depending on the type of IDR plan.
The new system, published in the Federal Register on Tuesday, would raise the income threshold for payments to $30,000 per year—so people making $15 an hour would not have to pay anything—and the cap would fall to 5 percent of discretionary income, half the previous rate. Plus, for those who originally took out $12,000 or less in student loans, the arrangement would terminate after ten years. That likely includes every borrower who attends community college. Every $1,000 above that would add a year, with a cap of 20 years for undergraduate loans and 25 years for graduate loans.
As long as payments are made, a borrower’s balance will not increase due to capitalized interest. However, even thinking about capitalized interest if your payments are designated through IDR is a bit off. Obviously, if you make a lot of money you will hit your balance before the time limit, so the government has to keep track of it. But borrowers do not; they just pay the percentage of income. And a new federal law allows the Education Department to pull income data directly from the IRS, so there would be no recertification process to turn in wage details.
This creates a system where the lender would make its outlays back if the benefits of the college wage premium manifest.
As I explained when this system was first previewed back in August, this creates a system where the lender would make its outlays back if the benefits of the college wage premium manifest. If the borrower has a successful career, they pay more; if it doesn’t work out, they would pay less, or even nothing. After 20 or 25 years, the relationship would end.
Currently, only about one-third of borrowers are enrolled in IDR, and that’s disproportionately skewed toward people with higher loan balances, which correlates with graduate students. But the new IDR system is a much better deal for undergrads and those with smaller loan balances. There is no auto-enrollment for IDR, and one key implementation will be to ensure that student loan servicers inform borrowers of the better deal available to them. It may take the government going around the servicers (whom it pays) to publicize IDR, including adding it to the initial student loan application form, to get the proper take-up.
But I think the benefits of the program will be obvious enough that, over time, you’d have virtually all student loan borrowers in the IDR system, at which point concepts like “balances” and “interest” are only really functional in the most extreme cases.
That leads to the downsides of this program, which the Biden administration has yet to address. A bulked-up IDR program that shields the true cost of higher education from students eliminates the price sensitivity that currently is the only check on costs. Colleges and universities would be able to increase tuition at will, since no student would balk at it, as government would pick up the balance on the back end. That could make IDR, for all practical purposes, a transfer from government coffers to higher-education administrations.
Now, there’s nothing wrong with the government paying a higher percentage of college education; the benefits certainly come back in the form of the higher tax revenues an educated workforce earns, as well as in a (presumably) more productive economy. But the government also doesn’t have to accept ever-increasing tuition, particularly if it’s unconnected to outcomes and spent on things like fancy gyms, climbing walls, and administrator salaries. It’s particularly egregious if colleges have giant endowments that they use as de facto hedge funds, yet continue to impose tuition burdens that ultimately under IDR would become a kind of higher-education welfare payment.
The solution is for the Education Department to condition the issuance of student loans under its Program Participation Agreement to those colleges and universities that lower their tuition costs and focus their budgets on the learning experience. With IDR, Congress has all the incentives it needs to keep costs down and prevent colleges from essentially scamming the government. (Many law schools already do this now with the Public Service Loan Forgiveness program, and the new IDR will tempt all colleges to follow suit.)
A tuition cap could prevent the rip-offs, and make sure that the benefits of more intelligently financing higher education are good for students, good for an educated workforce, good for focusing colleges on teaching rather than creating show palaces, and good for the economy as a whole. The more straightforward approach would be to directly finance public colleges, but IDR at least limits the overwhelming burden on students we’ve seen over the past couple of decades. IDR ends the student loan program as we know it, but it has to lead to something better. There’s a path for it to do so.
