How to make college affordable: no one is talking about the best and cheapest solution.

No one is talking about the best and cheapest solution

Unless your last name is Rockfeller, chances are you're unnerved by the sky-rocketing cost of a college education. Perhaps you've heard that between 1981 and 1995, tuition at even traditionally affordable public colleges increased by 234 percent--almost three times as fast as median household income. Not to worry. Help, or rather, the politicians are on the way. President Clinton has introduced a series of measures that, he claims, will make at least the first two years of higher education affordable for everyone. The good news is that Clinton's plan has sparked a spirited debate. Deep thinkers from both ends of the spectrum have come forward with proposals of their own. The bad news is that tEe most effective--and least costly--solution isn't even being mentioned.

The debaters fall into two camps. On one side are the tax break cheerleaders. Included in this category are hard-right Republicans, who favor a variety of measures--like allowing people to deduct part of the interest on their student loans--that are of dubious benefit unless you happen to be in a high tax bracket. Also in the tax break camp is Bill Clinton, who is touting a less regressive plan. Still, Clinton is hardly mounting a socialist revolution. One of his main proposals, to let families with incomes of up to $100,000 take a tax deduction of up to $10,000 for the cost of higher education, is as generous a gift to the upper middle class as anything the GOP could come up with. To mollify the critics, Clinton has also suggested a tax credit to allow families to keep up to $1500 a year for the first two years of postsecondary school. Since students would have to deduct any federal grant money they receive from the credit, the main beneficiaries would be those in the lower-middle class, who earn too much to qualify for grant assistance, but not enough to really gain from the deduction. The cost of Clinton's tax breaks: $36.2 billion over the next five years.

In the second camp are those who claim federal grants are the way to go. Members of this group include think-tanks like The Institute for Higher Education Policy, which recently co-published a report pointing out that even Clinton's tax credit is of no help to the people who really need it: low-income kids who can't afford to go to college. The meteoric rise in the cost of college, combined with the dramatic decline in government assistance, has hit these kids particularly hard. From 1981 to 1994 the real value of federal "Pell grants" fell by 22 percent. According to economist Thomas Mortenson's analysis of the government's Current Population Survey, today less than 10 percent of kids from low-income families earn a college degree--compared to 80 percent of those in high-income households. Instead of wasting billions of dollars on tax breaks for middle-class students who would go to school anyway, the grant advocates argue, why not spend it on more and larger grants to the neediest students? The Clintonites counter that the point is moot. To ask for anything more than the small Pell grant increase included in Clinton's budget is hopelessly naive, sighs David Longanecker, Assistant Secretary for Postsecondary Education. "We're working with a Congress that doesn't give us that option."

But by framing the issue as a choice between tax breaks or grant increases, Longanecker and the rest ignore a crucial point: there's a third option--one which is far more effective and a whole lot cheaper than either grants or tax breaks. What's more, this plan, or at least a flawed version of it, is already on the books. All that's needed is to get rid of the defects and to implement it properly.

The Third Way

The idea, in its ideal form, is deceptively mundane. Instead of requiring students to pay back their college loans on a fixed schedule, give them the option of taking out long-term loans that are "income-contingent." In other words, the student's monthly repayment is set according to his ability to pay. If his income is low one year, he will pay less back. If he gets a big raise the next year, his payments will go up accordingly. This plan is hardly new: it's been advocated for years by such diverse figures as conservative economist Milton Friedman, and neo-liberal writers Walter Shapiro, Mickey Kaus, and Timothy Noah.

The seemingly simple "pay-as-you-can" formula has enormous potential. And unlike tax breaks or grants, it helps people in all income groups. Working-class students who take out an income-contingent loan will not be forced to repay their debt in impossibly large installments--making them far less likely to default. Middleclass graduates who want to go into useful but low-paying fields, like teaching or social work, will be able to afford that choice. Lower-income kids contemplating college will no longer be discouraged by the fear of taking on a financial burden they might be unable to carry upon graduation. In short, if income-contingent loans were to become widely available, college could become affordable and accessible to everyone. An added bonus: since students would increasingly be the ones paying back their loans, they might be more likely to insist on getting their money's worth, spending less time partying and more time studying, and pushing their schools to reciprocate with lower prices and better quality.

Finally, there's the wonderful boon to taxpayers. Because unlike Clinton's tax breaks, which would set the treasury back $36.2 billion, or grant increases, which would involve additional government spending, a fully implemented income-contingent loan plan would be relatively cheap. The majority of the loans would be financed by the banks. As for the portion financed by the government, the loans would eventually be repaid. Thus the same sum of money could be used over and over again to help successive generations go to college.

How the plan SHOULD work

So what's the best way to make income-contingent loans widely available? Well since these loans may involve long repayment periods that make them potentially less secure and profitable, banks are unlikely to provide them without an incentive. And what better inducement than a little competition from Uncle Sam? By getting into the student-loan business the government would not be attempting to take it over--after all, why use taxpayer money if the banks are willing to do it? Rather, the aim would be to encourage more banks to offer students the pay-as-you-can option and--in the event the banks don't bite--to ensure that all students at least have access to it through the government's program.

There's plenty of precedent here. The Tennessee Valley Authority (TVA), for example, was established in 1933 in part to make cheap electrical power available to the area's inhabitants. The result was to spur nearby private companies, which had been charging twice as much as the TVA, to offer their own customers lower rates.

To prevent borrowers from lying about their income, banks could be allowed to forward cases of suspected cheaters to the IRS for verification. The penalty for fraudulent reporting would be severe. And the IRS could ensure repayment of government loans, as well as defaulted bank ones, by taking the repayments directly out of borrowers' paychecks, as if they were just another tax. That's better than asking people to mail in checks, and helps prevent defaults--not because the IRS has been operating at optimal efficiency lately (it hasn't), but because adding a line or two to the federal income tax form is a lot more effective than other means of collection.

To further sweeten the deal for banks, the government would guarantee income-contingent loans--as it already does with the garden-variety kind. At present about 10.7 percent of students default on their loans. Clinton can be justly proud of the fact that by clamping down on abuse, his administration brought the default rate down from a high of 22.4 percent four years ago. Presumably the pay-as-you-can option would make defaults even more rare--students would have as long as they needed to pay off their debt and, since the average college graduate earns $1.4 million over his lifetime, almost all of them should be able to swing it.

Practice Makes Imperfect

Unfortunately, although an income-contingent loan plan is already on the books--introduced and signed into law by Clinton in 1993--the program has yet to fulfill its potential. That's because both the legislation establishing such loans and the Clinton administration's efforts to implement it have been problematic.

To begin with, Congress kept the IRS out of loan collection. You would think this was the result of a heated argument between our elected officials over the danger of expanding the IRS's power, or the need to protect the sacred confidentiality of taxpayer records. Think ague. According to Steven Waldman in his book The Bill, the measure was killed because of turf squabbling by committee staffers in the House. The Education and Labor folks worried that involving the IRS would give their counterparts in Ways and Means an excuse to grab the student loan issue. The Ways and Means staffers hated the idea of tinkering with the IRS--and were outraged that they hadn't been consulted about this incursion on their territory. Anxious not to get bogged down, and mindful of the fact that they'd soon be relying on the Ways and Means staff to get the President's economic plan through the House, the administration caved. Who says politicians have all the power?

Petty though it was, this episode had unfortunate consequences. Whether offered by the government or banks, pay-as-you-can loans are unlikely to work unless the IRS is involved. And at this stage in the game, IRS involvement will not be an easy sell. After all, it's the agency everyone--particularly the Republicans who now control Congress--loves to hate. But a firm commitment from the President could go a long way. Instead of criss-crossing the country stumping for tax deductions, Clinton ought to be using his considerable powers of persuasion to explain the benefits of IRS loan collection. After all, the purpose of using the IRS would be to crack down on deadbeats--a point which ought to warm the hearts of hard-line Republicans everywhere.

While he's beating the drum for IRS involvement, Clinton could also talk about the second flaw Congress inflicted on the student loan program. Incorporated into Clinton's original plan was a provision to forgive income-contingent loans 25 years after a student has graduated, regardless of how much he has paid back. Although the 25-year forgiveness option had been floating around for years, the decision to incorporate it was, once again, dictated by staffers and disturbingly free of thoughtful debate. According to Waldman, a 20-year provision was thrown in at the suggestion of aides to Senators Nancy Kassebaum and James Jeffords just before the Senate mark-up--after a discussion of no more than 10 minutes. Later, in conference committee, the amnesty was changed to 25 years--again with minimal consideration.

Proponents of the forgiveness clause maintain that if it's taking someone such a long time to pay off their loan, chances are they are repaying it in installments that are so small they're not even covering the monthly interest on the money they still owe. As a result, instead of slowly chipping away at their debt, they are actually building up an ever-larger liability. What's more, anyone who is still in arrears after 25 years would by then be burdened with the additional cost of their children's education, so their debt ought to be forgiven. Ironically, under current law the amnesty hardly provides a free ride: borrowers must pay taxes on the amount that is forgiven, and these can be very high.

But the greatest danger is that by forgiving the loan, the government is, at worst, rewarding irresponsibility, and at best, over-compensating those who are happily pursuing their life's dream without having to worry about paying back the taxpayers who helped them accomplish it. Most importantly, the provision is fundamentally unfair to the folks who work hard to repay their loans before the cut-off.

Long-term loans of say, 35 years, are not without their disadvantages. As anyone with a home mortgage will attest, the longer the term of a loan, the greater the interest that must be paid on it. But just as long-term mortgages democratized home ownership in America, so can long-term student loans democratize higher education. Making those loans income-contingent would increase their impact still further.

As if the 25-year limit on income-contingent government loans were not troublesome enough, the banks face an even more severe restriction: a 10- to 15-year limit on the repayment period of the student loans they can offer. Although Congress took the positive step of requiring banks to give students the choice of income "sensitive" repayment (the bank version of pay-as-you-can), it left the limit in place. This was a crippling blow, because unless a loan is long-term, repayments on it (income-sensitive or otherwise) can never be made low enough to be widely affordable. Clearly, the 10-year limit must be removed.

Clinton has proposed some remedies, like requiring the banks to offer long term "extended" loans and lifting the 10-year limit on the "graduated" loans banks must now offer. (Under the latter plan the student pays back his loan in gradually increasing installments.) However, Clinton's proposal does not call for any change in the 10-year limit on income-sensitive loans.

A for Effort, C- for Results

That's not the only thing Clinton has done wrong The administration's well-meaning, but sorely misguided effort to implement the income-contingent loan plan passed by Congress has been equally damaging The problem is actually two-fold. To begin with, instead of trying to spur banks into offering pay-as-you-can loans by providing them with government competition, the administration has attempted to take over the student loan business altogether. As for the banking industry, it has responded by doing everything in its power to keep the government out. The result has been a stalemate.

The Clintonites' initial reasoning was that the old system of heavily subsidized banking entities [see sidebar] is expensive, enormously complex, and incapable of offering income-contingent loans. The only answer, they decided, was to get rid of the banks and start from scratch. If the government were to become the sole provider of student loans, it would no longer have to waste money on industry subsidies and guarantees. Students would also benefit because the cost of capital is lower for the government than it is for banks and, since it's not out to make a profit, the government could pass all of that savings on to students in the form of lower fees and interest rates. And the system would be more user-friendly for both students and schools--who would only have to deal with one lender, instead of thousands.

But while the administration was right to focus on problems in the old bank system, it was wrong to conclude that the solution is to consign that system to the dustbin. Remember, when the banks make a loan they use their own money--instead of that of taxpayers--so it's a good idea to keep them in the game. The Clintonites also fail to appreciate the value of competition. Not only can it force the banks to offer students better service and more attractive repayment options, but competition is an excellent means of preventing the government from running a sloppy program.

As for the massive subsidies currently paid out to the banking industry, all that's required is for the government to cut out the more outrageous perks, while carefully leaving intact those that are needed to keep the banks in business. Among the indispensable subsidies are those which enable banks to offer students the same low interest rates the government does. In administering these subsidies the government will have to err on the side of caution (or risk driving out the banks). Thus the banks will invariably receive at least a little more than they actually need. That's a necessary evil. However if the banks start taking advantage of the subsidies to undercut the government by offering significantly lower rates, it should be taken as a sign that there's still too much fat.

Sadly, the administration remains determined to replace the banks with "direct" government lending. Initially, it was expected that schools would switch over to the government's more user-friendly program in record numbers. But that was before the newly-elected Republicans in Congress--who were far more sympathetic to the banking industry than their predecessors--voted direct lending out of existence. Even though Clinton vetoed the measure, schools were spooked. If the government's program was in danger of extinction, why change over to it? Particularly since making the switch requires them to adopt a new system of paperwork and computer software.

By now the Clintonites have accepted that, for the foreseeable future, direct and bank lending will coexist. But that doesn't mean the administration has started pushing for the type of competition needed to make the income-contingent plan work. Instead, it is stuck in the old mind-set of competing with the banks to get schools to sign up for direct lending--and assuming that schools can only offer one program. That is the wrong approach. The best way to ensure that students get good service, low rates, and a well-administered pay-as-you-can repayment option is to make the government and the banks compete directly for students' lousiness. For that to happen, every school must be able to offer students both programs.

As a result of the administration's misdirected strategy, income-contingent loans are still not widely available. Although in the 1996 academic year almost 40 percent of students who took out federally guaranteed loans got them directly from the government, it's important to point out that only about 20 percent of schools offer their students such loans. True, after they graduate, students do have the option of consolidating their debt into one pay-as-you-can loan from the government. But the basic problem remains that at almost 80 percent of schools, students are not presented with the income-contingent option when they are first considering whether they can afford to finance their education.

To remedy this situation, the Department of Education must stop trying to convince schools to abandon the bank program and start making it easier for them to add the government's program to their existing mix. The case could be made to schools, which already deal with hundreds of banking entities, that taking on the direct loan program is no harder than adding another bank to their roster--particularly if the department makes itS procedures compatible with those of the banks.

The Department must also do a better job of explaining the benefits of income-contingent loans to low-income students. Numerous studies have shown that most low-income students are unwilling to take advantage of government assistance if it comes in the form of loans as opposed to grants. Not surprisingly, they are reluctant to borrow sums that are larger than anyone they know has ever laid eyes on--let alone earned. With the pay-as-you-can option, they will never face repayments that are more than they can afford. But low-income students are unlikely to appreciate that unless a concerted effort is made to educate them about how to make wise use of the income-contingent option. The textbook-style loan handbook currently distributed by the department isn't going to do the trick.

If Clinton really is committed to making higher education affordable for every American, he has much to do: Instead of fighting to get low-income students meager grant increases, he needs to focus on making income-contingent loans available. Instead of defending expensive tax breaks which disproportionately benefit the upper middle class, he needs to lobby for legislative changes--like getting the IRS in on loan collection, lifting the 10-year limit on bank loans, and removing the 25-year amnesty--that are needed to make the pay-as-you-can option viable and fair. A fully implemented income-contingent loan plan offers an incredible opportunity to make higher education widely accessible, without burdening the government with huge expenses. Unfortunately, as long as the issue is framed as a choice between tax breaks and grant increases, the best answer to the college affordability crisis will continue to languish in post-legislative limbo.

RELATED ARTICLE: Guaranteed Rip-Off

While it's a good idea to keep commercial banks in the student loan business, the current system is badly in need of reform. Back in the 1960s, when the federal student loan program was first established, banks were wary of lending to young students with no credit history and no collateral. To entice them, the government offered to subsidize and even guarantee all student loans. Although these loans have since proved extremely profitable, almost all of the original perks are still in place. In 1996 the government paid out $3.6 billion in subsidies and guarantees to generate $16.4 billion in loans--that's about 22 percent in overhead.

The system is clearly bloated with overly generous handouts. To Clinton's credit he wants to cut many of them, for a total savings of $3.47 billion over five years. Among the worst perks are large bank subsidies and unnecessary benefits to secondary markets (like "Sallie Mae") that buy loans from them. But by far the most outrageous racket is being run by the system's middlemen: the "guaranty agencies." These quasi-governmental entities use federal funds to reimburse banks for defaulted loans and then attempt tO collect the money from students. If they succeed, they get to keep a whopping 27 percent of what they recover--compared to the average 18.5 percent private collection companies pocket. If they fail, they just pass the bill on to Uncle Sam.

Clinton estimates that by lowering the 27 percent rate to 18.5 percent, taxpayers would save $457 million over five years. In addition, he predicts a five year savings of $110 million by making banks pay the allowance guaranty agencies get for attempting to prevent defaults--money they keep regardless of whether they are actually successful. Then there's the $690 million students would save if guaranty agencies were prohibited from charging them a one percent fee. That's on top of the administrative fee the agencies charge the government. Finally, there are the $25 billion in government reserves the agencies are sitting on. The reserves were originally intended to help agencies cover defaulted loans. But since almost all reimbursements come directly from the government, the reserves are unnecessary.

Clinton is right to try to cut all this fat out. But he faces a tough fight against a powerful foe. Although the biggest guaranty agencies are technically not-for-profit corporations, these enterprises are some of the most lucrative in America. The largest, part of a company called USA Group, earned over $100 million in tax-free revenues above its expenditures in 1995. USA Group's then-CEO Roy Nicholson got a $1 million salary that year, and its top 6 officials averaged $400,000 a piece. These executives have their offices in the company's sleek $32 million Fishers, Indiana headquarters. And they make large campaign contributions to sympathetic Republicans. The Baltimore Sun's David Folkenflik reports that USA Group executives gave out more than $30,000 in personal contributions in 1994 and almost $70,000 in 1996. The firm has also paid over a million dollars to Washington "consultants"--all for the purpose of preserving the system which has served it so well.

USA Group argues that the fees it charges allow it to provide high quality service, and the salaries it pays attract executives who must also run for-profit affiliates.

But this raises the question of why guaranty agencies need to be non-profit in the first place. They should either be privatized, and forced to offer competitive prices and pay taxes on their profits, or they should be replaced by the IRS, which would simply add loan repayment to the tax it already collects--eliminating much of the 22 percent in overhead the government currently spends to generate student loans.