Should Student Loan Repayment be a Tithe?

The $1.2 trillion in U.S. student debt has been generating a significant amount of debate lately. Education debt has exploded in the aftermath of the collapse of the housing bubble and the during the Great Recession. And with a change inserted into the 2005 bankruptcy reform bill passed during the Bush administration, getting out of that debt due to insolvency is unlikely. With federal loan obligations growing in spite of tremendous budget pressure, some politicians, particularly those on the conservative right, have advocated having the federal government out of the guaranteed loan business entirely. But if the government will not guarantee uncollateralized student loans, why would the private sector fund those loans at a level that would be meaningful?

Megan McArdle, a finance and economics columnist at Bloomberg, wrote recently that she participated in a working group that brainstormed on a possible alternative to the standard student interest loan: a tithe (my term–she referred to the concept as an “income sharing agreement”). A tithe is where loan repayments would be based on a percentage of income over a set number of years. Her excellent article discussed a number of wrinkles to this approach, such as how much income would be tithed, the costs of administrating such a loan, whether lenders would discriminate against certain majors, the possible impact of state usury laws, the impact of bankruptcy code, and whether financiers would be interested in underwriting such loans.

I find the discussion of a tithe interesting, but for an entirely different reason. Student loans exist because there is demand for a way to pay tuition at colleges, trade schools, and universities in something other than cash. What student with no work experience and no money can afford post-secondary education? Demand is so great that tuition has been jacked up far in excess of inflation every year for decades. Although there is recent evidence that tuition has risen so high that demand has slackened somewhat, one effect of this phenomenon is undeniable. Demand by students and greed by schools has had a far larger impact on student debt levels than the easy credit offered by the federal government and tough bankruptcy laws.

For those of you that are thinking that this is a chicken-and-egg argument, I respectfully disagree. Certainly demand for loans is powered somewhat by the willingness of the federal government to subsidize them. But the willingness of the federal government to subsidize loans is not because of some sort of elasticity in economics. No, Congress is motivated by politics. Politicians like to buy constituents with political favors, and nothing sells better than education. Cheering on this pork barrel spending are the schools themselves. Other than politicians who are fiscal conservatives, there is so little political friction apposing student loan subsidies that there is actually more credit available than that required to fund the supply of education. Which in turn has expanded the number of schools and programs seeking to sop up some of that economic excess by creating more supply. Which has created more debt, and in some cases, lowered the quality of education.

To understand what the decades-long steep increase in tuition really means, it helps to look at the difference between community colleges and four-year institutions.

Community colleges have a very different mission than other education institutions. They exist to provide affordable educational options to local residents who for one reason or another cannot take a three-to-five year hiatus from life at a four-year school (for profit or non-for-profit). And they are typically partially funded by the county or city for which they serve with an eye on keeping tuition low. So tuition is cost minus subsidy. And since the subsidy cannot rise generally faster than the budget of the local jurisdiction that funds it and the fact that local governments have an ultimately limited ability to run at a deficit (they cannot issue fiat currency to inflate their way out of debt), increases in tuition stay low. Federal student loans are available for community college students, but this inflationary effect is generally offset by the local government’s desire (since they control the purse strings) to keep tuition low as a viable alternative to four-year schools.

Contrast the above with the economics of 4-year schools. Because of high demand from easy money and low supply they in effect have had no limits on tuition and fees. This goes for state schools as well as private institutions. Although tuition and fees at state colleges and universities in theory would be limited by the constraints on state budgets, this has in fact not been the case. Most state schools’ portion of their costs funded by their state has been falling for decades and for many is in the single digits.

Ultimately the only constraint on cost for 4-year institutions is their ability to persuade potential students that their net income after paying down a student loan will be higher in the long run than the income earned without a degree. Which brings us to the crux of this commentary. Tuition, in reality, is already based on a tithe. Students pay a portion of their future income to the schools in exchange for the degree that will allow them to earn the income they need to pay back the tuition. They hand over their future income in the form of tuition and fees for the promise of higher income.

This has fueled a perverse game by 4-year schools and their graduates. Schools commission studies to show that students with a degree earn more income than those that do not. Graduates, most of whom are paying on student debt incurred to earn their degrees, in an act of self-justification will only hire other college graduates at their place of employment. Thus their schools’ prediction becomes a self fulfilling prophecy.

A loan program that bases repayments on a percentage of future income is in fact the most economically accurate manner in which to fund student education. Of course intellectually it is horrific–no student wants to be suckered into a pay-to-play arrangement with a predetermined outcome. No, what students want is a piece of the American dream. What they want is the promise of a small bit of upfront sacrifice that unlocks unlimited potential. The very thought of being enslaved to a corporate master in order to pay down student loans and being subject to the arbitrary whims of that master should invoke the revulsion that it deserves.

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