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In Need of a New Approach for Financing Higher Education

posted by David Moss

Over the course of this week, I want to discuss student loans, including the inadequacies of the existing system for financing higher education and a potential strategy for improving it.
As I see it, the current patchwork of programs for covering college tuition makes little sense. The system is maddeningly complex. What’s worse, it does a poor job of managing risk and assessing need, and it actually discourages household saving. Most student loans, moreover, require borrowers to bear the heaviest burden when their earning power is lowest. For such a major lifetime expense, it is imperative that we do better.

I’ll suggest an alternative approach in my next post. First, though, I want to focus on the nature of the problem we need to solve.

The Current Patchwork: A Deeply Flawed System

Under the current regime, parents who begin saving for the looming cost of higher education when their children are young face enormous uncertainty about what sort of college or graduate school their kids will attend, if any, and how much it will cost a decade or more in the future. They also face all of the standard risks associated with saving over a long time frame, including market risk, inflation risk, and default risk. And of course there is the risk of not being able to continue saving as a result of adverse income shocks, stemming from disability or disease, for example. The absence of any meaningful way to manage most of these risks in the private marketplace undoubtedly depresses savings. Those families that do save, moreover, are frequently punished by the system of need-based financial aid, which privileges families with little or no savings at all.
For their part, college students who borrow to cover tuition often place themselves in considerable financial jeopardy. Heavily in debt coming out of college, they can ill afford any substantial delays in finding a job or any significant interruptions once their careers have commenced. They also may find it financially difficult or impossible to pursue less remunerated career options, such as teaching. In general, there is something rather strange about a system that imposes the burden of one of life’s major expenses primarily at the beginning of a career, when earning power is lowest.

One additional oddity of the existing system is that determinations of need are generally based on the current financial condition of the student’s family, rather than on the future financial capacity of the student herself. Yet it is the student, not the family, who receives the benefit in the form of higher education and (in most cases) higher future income.
Indeed, an investment in higher education typically pays a substantial return. According to the non-profit College Board, the median earned income of college graduates was more than 60 percent greater than that of high school graduates in 2005.[1] Although not all college graduates command such a premium, many do. Under the current system, however, determinations of need are made before anyone knows how big or small the return on a student’s investment in college education will be. If it were possible to look into the future, wouldn’t it be better to ask those with the highest returns to cover their own tuition, and to target our assistance dollars to those who end up with the lowest returns and are thus least capable of repaying their loans?
Fortunately, I think it is possible to target subsidies in this way, and I’ll suggest a potential way of doing it in my next post.

[1] “Education Pays,” Second Update, Trends in Higher Education Series (College Board, 2006).


Surprisingly, some of the few places that do what you're suggesting are top-tier law schools. Law schools charge more up front than less lucrative degrees such as Ph.D. programs, but a small number of them offer loan forgiveness plans for students who take lower-paying jobs. Coming out of Harvard, I spent my first three years clerking and working at a non-profit. During that time, the school covered a full 100% of my student loans.

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