Abstract
There is wide agreement that the US student loan system faces significant problems. Seven million borrowers are in default and many more are not repaying for reasons such as returning to school, or economic hardship. The stress of repayments faced by many students results at least in part from the design of US student loans. Specifically, loans are organised like a mortgage, with fixed monthly repayments over a fixed period of time, creating a high repayment burden on borrowers with low income. This paper draws on the experience of the income-contingent loan (ICL) systems operating in England and Australia, in which monthly or two-weekly repayments are related to the borrower's income in that period, thus building in automatic insurance against inability to repay during periods of low income. We discuss the design of this type of loan in detail since such an exercise seems to be largely absent in the US literature. Drawing on data from the US Current Population Survey (CPS) we provide two main empirical contributions: a stylised illustration of the revenue and distributional implications of different hypothetical ICL arrangements for the USA; and an illustration of repayment problems faced by low-earning borrowers in the US loan system, including a plausible example of adverse outcomes with respect to Stafford loans. Importantly, we compare repayment burdens under the existing and alternative systems. Our illustrations show how US mortgage-type loans can create financial difficulties for a significant minority of US borrowers, difficulties which an ICL is designed to address. We note also that the current small and ineffective income-based repayment system in the US has few of the characteristics of an ideal ICL.
Highlights
This paper examines potential reform of student loan arrangements in the US
The issues are addressed in several ways, including conceptual and empirical examination of the Australian and English approaches to the design of student loans, which in both countries is based on a universal income-contingent loan (ICL) system
Unlike other variants of US student loans, the income-based repayment (IBR) shares a major feature of ICL: monthly repayments depend on a debtor’s future income
Summary
This paper examines potential reform of student loan arrangements in the US. The issues are addressed in several ways, including conceptual and empirical examination of the Australian and English approaches to the design of student loans, which in both countries is based on a universal income-contingent loan (ICL) system. Our empirical exercises are original contributions with respect to the US debate about different student loan systems – the current mortgage-style Stafford loan and a hypothetical ICL which differs in fundamental ways from the current income-based repayment (IBR) loan in the US. Good design requires: Insurance: if consumption smoothing is to be effective (that is, people borrow enough to finance the efficient amount of investment in human capital), the loan needs in addition to provide an element of insurance against low income. DIFFERENT INCOME-CONTINGENT DESIGNS An income-contingent mechanism has two generic forms: With a graduate tax (as in Friedman), borrowers repay a fraction of their earnings for life or (say) till retirement This is equity finance: repayments are contingent on lifetime income; people with higher lifetime earnings repay more in presentvalue terms. KEY ELEMENTS IN DESIGN The core elements of an ICL are: The repayment rate(s), that is, repayments as a per cent of a person’s current income;
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