Earlier this week, I suggested that we consider a new system of income-contingent lending (ICL) to ensure that every American can cover the cost of higher education. Surprisingly,
the notion of income-contingent lending, now viewed as a liberal idea, was
originally conceived by a well-known conservative economist. Milton Friedman suggested a federal ICL-style
program to help finance professional education as early as 1945, and he
extended the proposal ten years later to cover virtually all higher
education.
In Friedman’s view, the
market system on its own produced “underinvestment in human capital” as a
result of “an imperfection in the capital market.” Private lending for investment in human
capital (education) was far riskier than for investment in physical capital
(plant and equipment) because the former could not be collateralized – i.e., because
slavery was prohibited. The government,
however, could effectively collateralize human capital given its power to tax
future earnings. As a result, a federal
ICL program would, in Friedman’s words, “make capital more widely available [to
students] and would thereby do much to make equality of opportunity a reality,
to diminish inequalities of income and wealth, and to promote the full use of
our human resources.”
The economist (and
Kennedy advisor) James Tobin not only supported the idea of income-contingent lending, he actually helped put such a
system in place at Yale University in the early
1970s. Yale’s Tuition Postponement
Option obligated borrowers to pay 0.4% of their adjusted gross income, for up
to 35 years (or until their cohort had repaid its debt in full), on each $1000
of tuition postponed (borrowed). The
repayment schedule included both a minimum ($29 per $1000 borrowed) and a
maximum (150% of principal, scaled up year by year according to a variable
interest rate). The program was
ultimately terminated in 1978, in large part because of problems with
collection and unexpectedly high payments required of high-income
graduates. Still, the program offers
important clues about how best to structure a federal ICL program. It also helped many students from low-income
families afford a Yale education, including one particular Yale law student
named Bill Clinton.
In fact, it was probably
no coincidence that as President,Clinton initially favored an income-contingent approach in reforming the nation’s
system of financial aid. Yet his ICL
proposal faced strong opposition from private lenders. In the end, the watered-down version of an ICL
plan that President Clinton signed into law in 1993 was so weak that it had
barely any effect on student borrowing and has gone largely unnoticed.
The ICL idea was
employed with considerably greater success – and fanfare – abroad. Beginning in the late 1980s, a number of
countries adopted ICL programs to help cover university tuition, including Australia (1989), New
Zealand (1992), and the United Kingdom (1997). Although many of these programs appear to be
working well, it is doubtful that any would be directly transferable to the United States,
given substantial differences in country context. Most of the foreign programs, for example, exhibit
only a weak market orientation – in most cases charging no interest on loans. The sums involved are also much smaller than
they would be here, since the U.S. is effectively in a league of its own with respect to tuition levels. Still, the spread of income-contingent
lending overseas is important, reflecting the broad appeal of the idea and providing
a solid empirical basis for determining the best ways to structure a program
here at home.
This paragraph draws on
Yael Shavit, “Promoting Equal Access to Higher Education: the Past and Future
of Income Contingent Loans,” unpublished draft, January 2007. While program details vary from country to
country, Australia’s
program is reasonably typical: students can borrow up to the cost of tuition
and, after graduation, pay 4-8 percent of their income each year until the
principal (adjusted for inflation) is fully repaid. No payment is required in any year in which
the borrower’s income falls below a threshold level, which currently stands at
about AU$38,000 (approximately US$30,000).
