As I wrote in a previous post (here), financing college costs is best thought of as an investment in human capital: What’s the cost of college? What’s the cost of financing? What’s the expected return on investment? Does it make sense to finance so much many for such a return? Sadly, too few parents and colleges help students seriously consider those decisions–nor the consequences of choosing poorly. (Of course, it’s in the college’s best interest not to.) Consequently, college grads in the US have over $1 trillion in outstanding student loan debt–and for many, little realistic hope of getting out from under it before their own children, or grandchildren, are college-age.
The State of Oregon last week passed a proposal that could radically change the way students pay for public colleges in that state, using an investment model in the human capital students develop. It looks like it could be a great step in a helpful direction…but a step with some serious potential flaws depending on how the actual program is put together. The proposal, as described in a New York Times article (as well as here and here), would allow students to attend public colleges in Oregon with no up-front cost, but would require students to pay up to 3% of their future earnings for up to 24 years (the Times reports that proponents believe 20 years would be about right). This model puts the onus on the colleges to make sure students are employable, and at salaries that will eventually pay back the cost of education. That’s not necessarily a bad thing.
It also means that the colleges take on some risk around graduates’ future earnings, but with some possible rewards. If students end up earning less than anticipated the student has no obligation to pay a certain dollar amount or rate of interest, only the (small) percentage of their incomes. Because it is not a loan, there is no taxable “forgiven” value at the end of the repayment period, unlike the federal student loan income-based repayment plan. Colleges assume the risk of receiving less money. But because the investment contract is not a loan, there also is no cap on the potential revenue the school could generate on their most (financially) successful graduates. Clearly, high-earning grads will end up subsidizing low-earning grads.
And this is where the problems begin to emerge. Not in the idea of cross-subsidization; that’s an important aspect of any investment model–the whole idea is to diversify so the (financial) winners at least offset the (financial) losers. Where the problem lies is in how these investment contracts are “priced” and who actually bears the risks.
If the “Pay It Forward, Pay It Back” plan sets a common (or even a cap) repayment percentage across the board for all schools and majors, students will have little incentive to take the ultimate cost of education into account. Why would a student pay any attention to the cost of his school of choice when the amount he has to repay has nothing to do with the actual cost (and potentially, quality) of his education?
Likewise for academic majors. If the repayment rate is capped, then the cross-subsidization will not just offset the risk between more and less successful graduates, but between higher and lower-earning majors. It’s one thing for an investor to assume the risk of idiosyncratic personal success; it’s quite another to institutionalize a systematic subsidy for lower-valued degrees.
For this investment model to make sense, the “price” (i.e., the repayment rate) needs to reflect both the specific degree program and the cost of developing the human capital to begin with. That is, the repayment terms need to be based on actuarial analyses of expected earnings given the student’s degree program. And on the cost of the college the student chooses to attend (assuming not all Oregon colleges have the same cost structures). The program needs to be based on the idea of breaking even not across all students in general, but on students having similar expected earnings based on their human capital investment.
Finally, there is the question of who is actually bearing the risk. Is it some State-level fund or is it the individual schools? If the schools are not the parties sharing in the risk of low future earnings and in the reward of good future earnings, then the direct positive incentives for schools to focus on preparing students for future success disappear. In that case, it’s all the more important that repayment pricing reflects actual probabilities of future success–as repayment rates for schools that are less successful in preparing students for higher lifetime earnings will need higher repayment rates (as a percentage of future income) than other schools offering similar degree programs at similar cost. Such a pricing difference would promote competition among schools as students would opt for schools that–all else equal–will extract less from their future paychecks.
Since schools arguably have better information about the (economic and educational) values of their degrees, their costs of education, and their career placement rates, it makes sense that the schools–rather than some other State agency–should be involved not only in setting their own repayment rates, but in sharing in the investment risks of their students’ future earnings.
It will be interesting to see how the Oregon proposal comes together as the details–and all their devils–take shape over the next year.