A Better Path to Dealing With Student Debt Problems
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Commentary

A Better Path to Dealing With Student Debt Problems

A better solution to the nation's ballooning student loan debt may come from the private sector in the form of income share agreements.

In the U.S., student loan debt now totals over $1.5 trillion, with over 44.7 million borrowers. In response to growing concerns, many of the 2020 Democratic presidential candidates are proposing policies to wipe out existing debts and make public universities tuition-free. But several debt-forgiveness programs already exist and cost billions of taxpayer dollars annually, and the new proposals are increasingly raising fairness issues.

Many of the taxpayers who would be required to fund these student loan proposals worked their way through college or did not attend college at all, including some who may have chosen to skip college in order to avoid acquiring student loan debt.

Sen. Bernie Sanders’ (I-VT) very generous proposal would forgive all outstanding student debt in addition to eliminating tuition at all public colleges, universities, and trade schools. Sen. Elizabeth Warren’s (D-MA) plan would cancel up to $50,000 of debt for individuals with household incomes below $250,000 and “eliminate the cost of tuition and fees at every public two-year and four-year college in America.”

Other presidential candidates have signaled their support for debt-forgiveness or tuition-free college, but do not have specific proposals. Although they’re not usually mentioned by presidential candidates, several state and federal programs already provide debt forgiveness to individuals with student loan debt.

The federal government currently administers four programs—known as income-driven repayment (IDR) plans—that scale student debt payments to a borrower’s income and include some level of debt forgiveness. Generally, the programs set monthly payments at 10-20 percent of a borrower’s discretionary income and forgive the remaining balance after 20-25 years of payment.

A 2016 report from the U.S. Government Accountability Office found that participation in IDR programs grew significantly between 2013 and 2016, resulting in costs more than double what was originally expected for the loans made in fiscal years 2009 through 2016. The GAO report estimated that taxpayers would be on the hook for $74 billion in unpaid student loans under IDR plans.

The idea of scaling student loan payments to a borrower’s income makes some sense, but it isn’t unique to federal IDR programs. First proposed by Milton Friedman in 1955, income share agreements (ISAs), also known as human capital contracts, offer a privately-financed alternative to federal student loans and IDR plans.

Under ISAs, colleges or private companies pay a portion of a student’s costs in exchange for receiving a percentage of their income for a fixed period of time after they graduate. Purdue University’s ISA program, Back a Boiler, for example, has provided students with over $10 million since 2016. The terms of individual contracts vary depending on the amount borrowed and the average incomes for different majors, but the financial obligations under most arrangements are comparable to traditional loans.

One advantage of ISAs is that borrowers don’t accrue interest over time, but the amount paid is still often greater than the principal amount borrowed. Purdue provides a comparison tool that allows students to determine if an ISA would be more affordable than a traditional student loan. Since ISAs scale their payments to post-graduation income, they can be less risky for students pursuing majors that lead to lower-paying jobs on average. For example, if a history major borrows $10,000 through Purdue’s Back a Boiler program, they would pay 3.85 percent of their income for 112 months (9.33 years). Total payments under this arrangement would be $14,967 compared to $15,727 for a federal PLUS Loan or $17,125 for a private loan, according to estimates from Purdue’s comparison tool.

Income share agreements are just one way that the responsibility for student loans can be shifted from the federal government to individual universities and the private sector. Arrangements like ISAs, grants, and scholarships are better options and provide better solutions to the student debt crisis than taxpayer-funded debt-forgiveness or tuition-free college.

Vittorio Nastasi

Vittorio Nastasi is a policy analyst at Reason Foundation where he works on Florida policy issues including education reform and water quality management.