The US needs to rethink the way it finances higher education. Multiple generations are already set to struggle under the burden of $1.5tn in outstanding student loans.
Some colleges think they have found a solution in “income share agreements”.
Under these arrangements — also known as human capital contracts — a funder finances a student’s education in exchange for a small percentage of their income, paid over a certain period of years. The payment varies with the borrowers’ actual income, unlike traditional student loans, which require the borrower to repay a fixed sum. Though originally proposed by Milton Friedman in 1955, these agreements have come into their own only in the past few years.
The problems with the US’s student loan system scarcely need rehearsing. More than a quarter of federal loans to undergraduates will end up in default, and half of borrowers will fail to make a dent in their loan principal within the first five years of repayment. Debt proceeds go to colleges, while the risk of repayment falls on borrowers and, if they default, on taxpayers. This provides little incentive for schools to contain costs. As non-payment rates and defaults have mounted, college costs have relentlessly climbed.
We should replace this system with an “equity” model, in which funders pay for a student’s education in exchange for a stake in their future success. Students who achieve high earnings — tech engineers, bankers — would pay back more than the cost of their education. Their lower-earning peers — high school maths teachers, Salvation Army workers — would pay back less. This model works because high-earning students would subsidise their poorer peers, giving all students affordable payments.
Aspects of this already exist in Australia and the UK, where students repay a percentage of earnings over a minimum threshold. Our recent report for the Manhattan Institute found that dozens of American educational institutions are experimenting with this model. Purdue University, in Indiana, has one of highest-profile programmes. Students there can receive funding of up to $33,000 on top of lower-cost federal student loans. This replaces higher-interest private loans or borrowing by their parents. Students then pay back a small share of their income over the next seven to 10 years. Several other schools, including Clarkson University, Lackawanna College and the University of Utah, have started similar programmes. A few offer more favourable terms to students in degrees that tend to lead to higher paid jobs, while most give everyone the same opportunities.
When colleges act as the funders, they become more accountable for the value of the degrees. If a student does not get a job with a reasonable salary, he or she might pay back less than the cost of the course. That gives institutions incentives to help their students graduate with a quality education and job placements — otherwise they lose money.
The US government sees merit in parts of this scheme, although it has not fully bought in. It now offers student loan borrowers the ability to enrol in various income-based repayment plans, where loan payments rise and fall with income. But these plans are administratively burdensome. And the funding is still in the form of loans: low-earners can see their balances grow as interest mounts up, while high-earners pay proportionately less of their income and do not subsidise lower-earning peers.
The US government must learn from those public and private universities that already have skin in the game. Let us design a larger-scale federal programme that is easier to understand and more affordable than today’s student loans. Colleges must be financially accountable for academic outcomes.
This could revolutionise higher education. It is time to give income share agreements a try.
The writer is a former president of Washington College. Preston Cooper of the American Enterprise Institute also contributed