Missing the mark on federal student aid

Two of today’s biggest proposals aimed at solving the student debt crisis – refinancing and expanding income-driven repayment – are well-intentioned but miss the mark. Better reforms would address the real problem of an outdated postsecondary education system, and would use the billions already spent annually on federal student aid more effectively.

The first proposal, refinancing student loans, is not new but is gaining fresh momentum. Last week, Sen. Elizabeth Warren (D-Mass.) announced plans to introduce legislation in the coming weeks that will refinance all outstanding loans to today’s subsidized Stafford loan rates, or 3.86 percent. The costs of refinancing will be paid for by the controversial “Buffet rule” tax increase on millionaires.

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Taxing the wealthy to reduce interest rates may help relieve high interest rate payments, but does nothing to address the underlying debt. The Department of Education informally estimates a refinancing scheme could cost upwards of $100 billion over 10 years, a high price to pay for a plan that does not hold schools accountable. And if the ability to refinance extends into the future, it would be cheaper to just offer all federal student loans at the subsidized Stafford rate.

Moreover, refinancing all student loans will mostly benefit graduate students and those with very high debt levels. This may not be the intended target for relief, as it allocates more funding to borrowers who made poor borrowing choices as opposed to those under the most financial stress. A more effective way to deal with graduate loans would consist of capping loan limits, and using those savings to launch a financial awareness campaign complete with labor market expectations data before people borrow.

The second proposal, being explored by Sen. Tom Harkin (D-Iowa), calls for making income-driven repayment (IDR - also known as “Pay As You Earn”) the automatic repayment plan for all borrowers. Under IDR, borrowers pay up to 10 percent of discretionary income regardless of loan amount, for a maximum repayment term of 20 years after which all outstanding debt is forgiven.

The costs of IDR are only beginning to come to light. New CBO estimates for expanding IDR as proposed in the president’s budget show an estimated cost of $8.2 billion over the next 10 years, although independent estimates range as high as $14 billion annually. Because this form of IDR is so new, the true cost will likely depend on programmatic details and implementation.

Similar to refinancing, IDR stands to benefit graduate students and high debt borrowers the most. In fact, there have already been documented cases of IDR abuse. Without accountability, expanding what was designed to be a temporary solution for the neediest borrowers simply hastens the transfer of the crisis of college affordability from the borrower to the taxpayer. It does nothing to address rising tuition. This suggests a one size fits all approach for loan repayment, or at least IDR in its current form, may not be the most cost-effective.

A better approach to reforming federal student aid would help students young and old by modernizing the postsecondary education system. Right now, there are too few acceptable pathways into the workforce after high school. The mentality that everyone needs a four-year degree is not only exacerbating the strain on the federal aid system, but it is enabling poor performing postsecondary institutions to stay in business.

One possible way to target industry reform is by experimenting with Pell Grants. The scope of Pell Grants could be expanded to include more non-traditional training programs. This would encourage alternative pathways into the workforce, for example, apprenticeships or online-based credentials. 

Another experiment could be to change the eligibility criteria for schools receiving Pell Grants. Grant money can be block allocated to schools by completion and post-graduate success metrics to start; later allocated by success metrics of recipients. This forces us to collect data on grant recipients over time while encouraging schools to better serve students. Such experiments can be done cost-effectively, by tightening eligibility criteria, reducing the eligibility period, and tying individual funding to progress benchmarks.

The effectiveness of Pell Grants is currently unknown, leaving room for improvement. We do know that emphasis on enrollment over completion and post-graduate success does little to help the recipient or taxpayer in the long run. Yet the program has a significant footprint: recent research shows about 9.4 million students received Pell Grants in 2012, up from 5.2 million in 2006. According to the CBO, the cost of Pell Grants simultaneously skyrocketed by 168 percent.

The interconnectedness of federal student aid programs with the postsecondary education system should be seized by policymakers as an opportunity. Focusing on effectively using existing funds to help borrowers, and modernizing the postsecondary education system, is the best way to address the student debt crisis now.

Carew is an economist and director of the Young American Prosperity Project at the Progressive Policy Institute.

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