Last week, President Joe Biden announced that the federal government would forgive between $10,000 and $20,000 of student loan debt for qualifying borrowers who make less than $125,000 per year. But that wasn't all: Biden also said that he would create a new income-driven repayment (IDR) system for college borrowers.
The IDR aspect of Biden's plan attracted less scrutiny than the direct forgiveness aspect, which will cost at least $300 billion (and probably much, much more) in the immediate future. But in the long-term, this aggressive move toward an income-driven model of repaying college loans will probably have a bigger impact—and that impact will be catastrophic. In fact, unless the government does something to constrain colleges' ability to set their own prices, IDR could break the entire higher education financing system and lead to skyrocketing costs for taxpayers.
There are some IDR programs available right now, but Biden's approach would vastly expand this option. The existing plans require borrowers to pay 10, 15, or 20 percent of their income for two decades, at which point the rest of the loan is forgiven. Biden would make IDR much more appealing than it is currently; according to the Biden-Harris debt relief plan, borrowers will pay just 5 percent of their income (or 10 percent if they took out graduate student loans) for either 10 or 20 years depending on how much money they owe. The income threshold will be raised from 150 percent above the poverty line to 225 percent, and punitive interest rates will be eliminated.
All in all, this IDR model will be extremely appealing for a large number of borrowers, and we should expect the percentage of borrowers who are repaying via IDR to increase substantially in the coming years. But without further changes to the federal student loan program, this is going to be a huge problem.
That's because both the borrowers and the universities will have increased incentive to bilk the people who actually make the loan: the taxpayers.
Under the current system, a prospective student needs a certain amount of money to pay for tuition at a university—say, $50,000—and borrows that sum from the government (i.e., the taxpayers). Later, the borrower pays it back, with interest. The university's incentives are less than ideal; it might feel free to raise the price of tuition to $60,000, satisfied that the student really wants the degree, and will thus borrow more money, and deal with the consequences afterward. To the extent that the government loan program disguises upfront costs, it arguably contributes to rising tuition rates.
Under IDR, this situation gets much worse because the university and the borrowers have incentive to cooperate and screw the taxpayers. For the borrower, it doesn't matter if tuition costs $50,000 or $5 million: The borrower will be repaying the same amount, 5 percent of income for 10 years, regardless of the size of the loan or the cost of tuition. Since it makes no difference to the borrower, the university might as well raise prices. This way, the university pockets more money, and the borrower doesn't even have to pay it back.
Something close to this scheme already exists in law schools, which have Loan Repayment Assistance Programs (LRAPS). According to leftist writer Matt Bruenig, the arrangement is very likely to produce increased tuition as universities and students figure out that they can essentially cooperate in this game to beat the house:
Just as schools have new incentives to push debt loads higher in an IDR-dominant world, so do students. Above, I say that, for students planning to enroll in IDR, $15,000 of student debt is no different than $100,000 of student debt. But this is not quite right. A student planning to enroll in IDR actually benefits from taking out the maximum amount of debt possible.
Student loans are initially paid to schools to cover the tuition and fees. But what's left after tuition and fees is disbursed as cash to the students, ostensibly to cover living expenses. In a conventional student loan, you have reason to live frugally and take out as little debt as possible. But if you are planning to go on IDR, then your incentives flip and you are leaving money on the table if you don't take out the maximum loan possible.
Even if you don't want to spend it living lavishly while in college, you could squirrel away the surplus into a savings account for later use, including for use in making your IDR payments after you graduate. Indeed, this is just a student-administered version of the LRAP scheme discussed above where student debt is used to pay off student debt.
Bruenig notes that Australia also uses IDR, but in Australia, the government prohibits universities from charging obscenely high tuition rates.
"If we are going to make the leap into an IDR-dominant college financing system, then we may need the government to also play a much bigger role in setting college prices, something it probably should have been doing even before the Biden policy change," writes Bruenig. "Otherwise, we may very well see more unwanted cost bloat beyond what we already have."
Bruenig approaches these issues from the left, but he's not wrong that these policies make for a dreaded combination: 1) letting students get publicly subsidized loans, 2) allowing the borrowers to pay a percentage of their income instead of paying back the loan, and 3) permitting universities to charge whatever they want for tuition. The result is that tuition will be meaningless as a pricing signal, and institutions will have no reason whatsoever to keep costs down; on the contrary, they would be foolish not to jack up tuition prices, since the broken loan system would be functioning as a direct wealth transfer from taxpayers to university coffers.
One solution would be for the government, at a minimum, to set tuition prices for public, state universities—which, after all, are public and paid for by taxpayers. If the state is going to confiscate wealth from taxpayers in order to maintain public educational institutions, those institutions should be generally affordable to those same taxpayers.
Another idea would be to move to a system in which students don't take out loans at all; instead of paying tuition, they agree to pay a percentage of their income to the university for some length of time after graduation. This would be like IDR, but it would cut out the government as the middleman, and thus get taxpayers off the hook. Purdue University President Mitch Daniels experimented with such a system, though it was paused earlier this year due to implementation difficulties.
By encouraging students to take on even more debt, and then never expecting them to repay it, the Biden administration is creating a system where everyone involved in higher education has incentive to fleece the American people.
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