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Promoting Investment in Education through Income-Contingent Lending

posted by David Moss

In yesterday’s post, I identified a number of problems with our current system for financing higher education, and I promised that I would suggest a new approach.

The option I think we should strongly consider is to ensure that every American can finance college or graduate-school tuition (or the cost of job training) with a special income-contingent federal loan. The loan would have an extended term (up to 30 years, like a mortgage) and would defer or potentially forgive interest payments for any year in which the recipient’s household income fell below a pre-specified trigger.

Income-contingent lending for education is certainly not a new idea. In the past, its intellectual champions included both Milton Friedman and James Tobin, two Nobel laureates in economics from opposite ends of the political spectrum. Among politicians, key supporters have included Congressman Thomas Petri, Republican from Wisconsin, and former Senator Bill Bradley, Democrat from New Jersey. The idea has broad appeal because it addresses an important weakness in our market system.

Just as limited liability law encourages investment in financial capital, an income-contingent-loan program would encourage investment in human capital by limiting the investor’s downside risk. In my view, it would represent a vital – and ultimately self-financing – policy innovation for the information age.

A New Approach to Financing Post-Secondary Education

An income-contingent-lending (ICL) program, underwritten and administered by the federal government, would help to address all of the problems I identified yesterday and would offer many other advantages as well. The key benefits would include: access for all students, fairness for students and families, efficiency in administration, and increased productivity for the nation as a whole.

Access for All

Most importantly, a federal ICL program would ensure that every American could attend college (or any other form of post-secondary education), based solely on merit and irrespective of need. Many parents would still save to help cover tuition, but they could rest assured that adequate financing would be available even if their savings fell short. And the financing – in the form of income-contingent loans – would involve dramatically less risk for their kids than traditional student loans. Although participating students would assume substantial levels of debt, they would have much less cause for worry, since they would not have to pay in any years in which their income faltered.


Fairness for Students and Families

In terms of fairness, income-contingent lending would offer a much better way of addressing need. Carol, who earned a high income after college, would be required to cover the total cost of her education (by repaying her loan in full); whereas Bill, who earned a much lower income after college (because, for example, he chose a career as a public school teacher), would get a break, though only for as long as his income remained low. With income-contingent loans, borrowers would also gain much needed leeway in the face of life’s unpredictable hazards, such as unemployment, serious illness, or natural disaster.


Efficient Administration

An ICL program would also make good sense from an administrative standpoint. Under the current regime, about three-quarters of all loans for post-secondary education are guaranteed by the federal government. For the most part, private lenders earn profit when the loans are repaid (as they are in the vast majority of cases), and the federal government is left holding the bag when they are not. In addition, the federal government often pays dearly for private collection services, which are frequently provided by the same lenders whose “losses” were already fully covered by federal guarantees. Although the question of direct versus guaranteed student loans remains controversial, numerous experts believe that the government’s direct lending programs are more efficient.

Under an ICL program, in which the federal government would lend directly to students, collection could be administered through the IRS, as part of the normal withholding system. Since repayment would be virtually automatic in most cases, delinquency would be reduced to an absolute minimum, which in turn would ensure the lowest possible interest rates on the loans themselves.

Clearly, the federal government would face sizable start-up costs, once it began issuing the new loans. Ultimately, however, as the loans were repaid, the program would become self-financing – apart from the funds necessary to cover interest deferrals and forgiveness for borrowers whose incomes fell below the trigger.


Increased Productivity

One final benefit is that by encouraging additional investment in human capital, an ICL program could help to raise national productivity. This would boost GDP, household incomes, and government revenues. Given the high returns on education in the information age, the program could, over the long term, pay for itself many times over.

** ** **

In my next post, I’ll explore precedents for an income-contingent lending program, both at home and abroad.


Hello David Moss,

Your entire article(post) about ICL program is a good interesting program, I liked your concept on ICL. You have nicely mentioned how this program going to raise national productivity. How ICL Program would boost GDP, household incomes, and government revenues.

Very informative and thinkable article.


I recently started researching ICL systems for the Roosevelt Institution's 25 Ideas on Higher Education Challenge. I think an income-contingent loan system would go a long way to address some of the major barriers to higher education, particularly the inability to predict one's loan amount ahead of time and protection from disability/job loss.

However, I have some questions/concerns that perhaps you've thought about and can shed some light:
1. How does the government keep higher education institutions from inflating tuition?
2. Would an ICL system discourage colleges/universities from providing need-based grants/scholarships?
3. Would an ICL system eliminate the need for Pell Grants?
4. What can an ICL system do to discourage free-riders?
And, 5. Do you think that this sort of system is sustainable if it is treated as a loan (with a definitive amount/time limit)? Or only if its treated as Social Security in reverse, such that the graduate pays a portion of his/her income for life?

Eva DuGoff

Some great information here, thanks much for posting!

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