US Elections: messing with the small print won’t address the issue of student debt

by Richard Murphy

Higher education finance might be the last thing on America’s minds when they cast their votes on Tuesday. However, the fact that both candidates have set out plans to reform the US’ student loan repayment schemes is perhaps indicative of the importance of this issue in the US. The problem is, both candidates are just messing with the small print, and their plans which will do very little to help graduates struggling with student debt.

Trump intends to push for an income-driven repayment plan that would increase the level of the payments students have to make (by increasing the cap on payments from 10 to 12.5 percent of income) but reduce the repayment period to 15 years from its current period of 20-25 years (depending on the scheme). Meanwhile Clinton has endorsed the current plans, with the caveat that she aims to simplify the number of plans.

But will these proposals help students who are struggling with their loan repayment? The short answer is no.

America is one of many countries in which students take out large student loans. The average undergraduate debt for graduates in the US is $30,000. In Australia the average student debt on graduation is $22,000, and in the UK it is $66,000. Yet it is the US that has the most difficulty with graduate default rates.

The reason for this is the US government does not make it easy for students to manage their debt.

The standard American repayment plan has graduates paying back a fixed amount each month regardless of their economic circumstance. It is this repayment system – where students who might be unemployed or earning very little can end up repaying the same amount per month as the highest earning graduates – which leads to a high level of default.

In the other countries, students are automatically enrolled in an Income-Based Repayment (IBR) plan – in which debt is repaid as a portion of students income – and stay in it until the debt is repaid (or time limit is reached). Such schemes are available in the US – hence Clinton and Trump’s interest in them – but they are not widely used. Thus, the candidates’ plans to change the parameters of these plans will only have a marginal impact on the lives of graduates or the wider economy.

So why aren’t these more favourable schemes more widely used in the US?

In the US, graduates have to apply through a loan servicer to complete a 10-page application which will generally take months to be authorised, and re-apply each year (many do not manage to complete the paperwork in time). Graduates will then need to submit income information annually, in order to be told how much they will have to pay during the next year. In other countries, this salary information is obtained automatically through tax records. A further problem is that in other countries, the amount that has to be repaid is based on a graduate’s present monthly income and taken out of their wages automatically. Hence, if the graduate finds themselves made redundant, they will only have to worry about rent and bills, and not about student loan repayments and their credit rating. But, in the US the current IBR plans are based on the income from up to two years ago, meaning graduates would still be expected to make their repayments up to two years after a fall in income.

So what if we managed to enrol more US students in these schemes? What would be the effect on the US taxpayer? IRB plans will not lower the nation’s student loan debt, but they do make paying back the money owed to the federal government potentially easier, likely meaning that the government would end up with fewer defaults and more income from loan repayments.

Moreover, having more flexible repayment schemes can mean that graduates will look for the job that fits their skills better rather than taking a low paid job to cover the loan. This benefits both the country and the graduate, as neither want overqualified individuals not using their skills to contribute to society.

And would Trump’s shorter repayment period make sense? International experts on student finance are generally against the premise of paying back loans over shorter periods (e.g. Dynarski, Barr). A core principle of finance is that the repayment period should align with the use of the asset. We pay back loans for cars over a short period than we do for houses for this reason. For education the financial returns are gained over a life time and so one would think about extending the repayment period, with a smaller payments each month. For comparison the repayment periods for Germany, Sweden and England are 20, 25 and 30 years respectively. Extending the IRB period also has the benefit of increasing the chances that the original loan will be repaid, without the graduate defaulting.

From this perspective then, it seems that sticking with the current IRB schedule, but simplifying and adjusting it to make it attractive many more students in the US, would make most sense. Simply making minor adjustments to the terms – as Trump and Clinton plan to do – will make little meaningful difference to the life of graduates.

 

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