What’s the Alternative to a Mountain of College Debt?

Meet Sarah, a very bright student in her junior year in high school. She excels in math and science and thinks that an engineering career of some kind would be her cup of tea. She wants to go to a college or university where a strong academic program will give her the knowledge she needs.

Sarah’s family, however, is not wealthy. In fact, they’re in the bottom income quintile and have nothing saved for college. They have thought about letting Sarah start at a nearby community college, which would keep the cost down to a level they could afford. The drawback is that spending two years there would be an educational waste of time since the coursework would be like repeating high school for Sarah.

Another option would be to take out student loans so she can afford to go to a university known for its high-powered engineering program. The problem is that Sarah’s family has had a bad experience with borrowing, having lost a house in the last real estate crash. Her parents understand that Sarah will probably be successful enough to be able to make the payments on the loans, but the lurking uncertainty bothers them very much.

If only they had some wealthy family member who could finance that ideal college experience for Sarah, confident that she would pay him back after she graduates and finds employment. But they don’t.

But in a world full of people who have investable wealth, shouldn’t there be some who would willingly front Sarah the money for college as long as they’d get a fraction of her future earnings? That is, people who would see that the best college education for Sarah would also be a good investment for them if they could make a contract with her.

Most readers know that the concept of wealthy people investing in higher education for a good student who just can’t afford the right college is one that has been around for quite a few years. It’s usually called an Income Share Agreement (ISA). I first heard about the idea in a paper by Miguel Palacios published in 2002 by the Cato Institute.

Soon thereafter, a company named MyRichUncle tried to put the ISA concept (also called human capital contracts) into effect, but it failed financially in 2009.

No matter—many companies with good ideas fail. The ISA idea is a very good one, since it puts private capital into the college decision process, rather than easily obtained student loans that are ultimately the taxpayers’ responsibility. As Kevin James and Rooney Columbus explain in this American Enterprise Institute article, “This creative approach flips the traditional student loan model on its head: Because an ISA has no explicit principal balance or interest, the ISA provider only earns its money back if the student is successful. Compare this to traditional loans where students are on the hook no matter how things turn out and how burdensome loan payments may be.”

Getting government out of college finance is a worthy goal, but what if the government itself is part of the reason why the ISA concept has thus far floundered?

Several federal politicians think that is the case. Two in particular are from Indiana: Senator Todd Young and Representative Luke Messer. Senator Young introduced the Investing in Student Success Act in the Senate in February and Representative Messer introduced the same bill in the House in June, where it is called the Investing in Student Achievement Act.

The thinking behind the bills is that the current legal framework in the U.S. is not conducive to ISAs because of legal uncertainties. When potential investors have to worry about uncertainty, they are likely to hold back. Writing on Forbes, Preston Cooper observes that “private ISA funders who make the wrong call run the risk of being investigated or sued by overzealous regulators and state attorneys general.”

To remove legal obstacles to ISAs, the bills make a number of changes and clarifications so that investors won’t have to worry about possible legal pitfalls. They cover a number of eventualities.

With respect to the income tax, the bills provide that ISA funders would owe federal taxes on their earnings from an ISA in excess of the amount they originally provided to the student and that students would owe no taxes on the funds they receive.

Another big point is whether a student can get out of making ISA payments by declaring bankruptcy. The bills state that ISAs will not be dischargeable in bankruptcy, just like student loans. This makes perfect sense, since the objective is to help propel the growth of this alternative to debt. If ISA investors know that a student, no matter how good his or her chances of success appear to be, might be able to escape having to pay them back, fewer will be willing to accept the risk.

Furthermore, the legislation puts a cap on the percentage of income the student must repay at 20 percent. If, contrary to expectations, a student has low earnings, he or she will not have to pay more than 20 percent of those earnings to the ISA investors. That provision is probably included to make the bill more palatable to Democrats, and indeed Rep. Messer has attracted two Democratic co-sponsors. While I don’t care for any federal interference in the contract terms, this may be unavoidable.

A similar, “liberal” provision is that any time the student’s income falls below 150 percent of the federal poverty line, he or she will not need to make any ISA payments. So if Sarah had an ISA but for some reason her earnings fell to only about $22,500 (the poverty line for a single person this year being just over $15,000), she would not have to make an ISA payment.

Again, that meddling with the terms of the contract is an unfortunate but probably necessary feature for the bills to find backing among Democrats.

No doubt one reason why two members of Indiana’s congressional delegation are spearheading the fight to boost ISAs is that Purdue University in their state has begun a pilot program to provide students with this non-debt funding alternative. Using funds from the Purdue Research Foundation and some private investors, the “Back a Boiler” program is designed to assist students who need additional money for college but don’t want more debt. While this ISA program is not meant to replace federal student loans, if successful it will clear that path.

This Washington Examiner article about Senator Young’s bill explains the advantage of ISA financing with the case of a nursing student. “Purdue calculated her expected income after graduation. She was assigned a payment of 4.8 percent of her monthly income for nine years…. Her monthly payment will be around $200 – $300, whereas the monthly payment for her private loan would be $350 – $500.”

An important feature of the “Back a Boiler” program is that students who plan to pursue studies in fields with better paying jobs have lower repayment rates than those who plan on lower-paying careers. Commenting about the program on Forbes, Jon Hartley writes, “For instance, a computer science senior will pay 2.57% of post-grad pre-tax income over 7.3 years for $10,000 of tuition paid through an ISA, while a liberal arts senior will pay 4.52% of their post-grad pre-tax income over 9.7 years for the same amount.”

That’s the market at work. Its non-egalitarian calculations are rooted in economic reality about the relative risks of different majors. That’s as it should be.

The Purdue ISA program seems to be carefully thought out. The Martin Center will report on its future success (or perhaps failure). In any event, it is an approach that other schools should consider.

As for the ISA bills, they are stuck in committee. If and when they advance, we will also report on that. Congressional leaders ought to push them through to a vote because the ISA concept fits perfectly with their goal of decreasing Americans’ reliance on Washington.

  • DrOfnothing

    Ah yes, out of the goodness of their hearts (and for a fat tax refund) America’s 1% can sponsor Oliver Twist or Lil’ Orphan Annie to go to college, as long as they study whatever major Daddy Warbucks has in mind for them. Presumably, they’ll have a nice long period of indenture afterwards to, informally, show their gratitude. God forbid a student wants to study something that they have a passion for, instead of something that earns them more money, because the latter _has_ to be the entire purpose of their drone-like lives. The cruel, twisted logic of charging lower-earning students at a higher repayment rate reeks of the same ideology as Trump’s busted tax plan to make the middle and working-class pay more taxes while the rich pay less b/c it’s good for the former. This slavish adherence to “market values” is what brought us such high tuition rates to begin with. The wilful blindness of an argument that propose the same measure that caused the affliction as its cure is just staggering.

    Oh, and for the record, Liberal Arts majors, in the long run, actually earn _more_ than those who study pre-professional degrees. Talk about an “inconvenient truth!” https://www.insidehighered.com/news/2014/01/22/see-how-liberal-arts-grads-really-fare-report-examines-long-term-data

    • Liberty_and_Justice

      While I don’t know the actual distribution, my guess is that “professional and pre-professional” majors are dominated (in number) by nurses and general business majors. If “professional” includes mostly physicians, dentists, vets, and MBA’s, then I assure you that they are earning more, on average, than liberal arts majors. It is only because this categorization is diluted with the lower-earning fields that the comparison with liberal arts majors is even close. Those studying STEM fields earn considerably more, on average, as shown by the reported statistics.

      If you look at the report, the statistics show that liberal arts majors earn about 3% more that the pro + pre-pro majors on average during a 5 year period of their lives late in their careers (after age 55). For all we know, that is partly because many of the pro + pre-pro majors are already retired because they made enough money before 56 and are happily volunteering helping their communities. These are terrible, cherry-picked statistics to trot out to promote liberal arts study on the basis of earnings. Studying liberal arts is great, but many liberal arts fields of work simply do not pay well compared to other fields. My daughter is an English teacher, I know…

      Do you have any evidence to support that ISAs are invested in disproportionately by the top 1%? Or that anyone receives a tax “refund” for doing so?

      The ISAs discussed in the article are one method for society to fund education. Loans are still available. Work is still available. There is nothing to prevent “lower earning” students/workers from obtaining a loan. Do you have a problem with those who have investable resources freely offering them to those with need for resources freely receiving them in return for payment in the future via a simple and transparent agreement?

      It seems to me that it is not “market values” which have brought us high tuition rates– it is the easy availability of federal-guaranteed loans and the willingness of people to take those loans without considering the consequences.

      Maybe it is because they can’t comprehend the financial consequences because they were liberal arts majors?

      “God forbid a student wants to study something that they have a passion
      for, instead of something that earns them more money, because the latter
      _has_ to be the entire purpose of their drone-like lives.” Many people study subjects in school that they both have a passion for *and* which will earn them a living. They then have the rest of their lives to study whatever other passions they have. Most engineers and scientists I know grow in their knowledge of the liberal arts throughout their lives via self study that costs the rest of society nothing. Most liberal-arts majors that I know grow very little in their STEM knowledge or business knowledge throughout their lives. Which path is better for society?

      • DrOfnothing

        You bring up a number of valid points, so I’ll try to address them as succinctly as possible.

        1.) If you read the report itself, the methodology is quite rigorous. It’s all well and good to say “I’m dubious,” but you need specific evidence to back it up. It’s worth noting that this finding has been reflected in studies across the ideological spectrum, including the WSJ. https://www.wsj.com/articles/good-news-liberal-arts-majors-your-peers-probably-wont-outearn-you-forever-1473645902
        One thing to keep in mind is that a significant number of students who eventually go into higher-paying professions (e.g. Law) have Liberal Arts degrees. In the end, most evidence points to the conclusion that going to a highly-competitive college or university is more important than your major. For example, of the 25 colleges that have, on average, the highest-paid graduates, at roughly half of them, Social Sciences constitute the most popular majors. Engineering is second.

        2.) ISAs are too rare to make any solid conclusions from as yet. We do know, however, that any argument dependent upon the alleged munificence of those with lots of disposable income is on shaky ground indeed. The wealthy give much less to charitable causes, as a proportion of their salary, than the middle-class or even the poor do. https://www.theatlantic.com/magazine/archive/2013/04/why-the-rich-dont-give/309254/
        I don’t have anything against it, in principle, there’s just no evidence that it would work, based on past experience. It would get a lot of attention, and support for those who already object to state-funded HE (like the author), but it certainly is not a reasonable solution to college costs.

        3.) The explanation of why college costs more now is complex, to say the least, and debate is ongoing. The race for prestige, cuts in per-student state spending (despite overall increases), significant administrative growth (though this is not the prime reason, as is often claimed by JMC writers) have all played a part. A _major_ part of this is the vast expansion of both marketing and “student services” both of which are part of college’s cut-throat competition for students. So yes, market forces play a very strong role in soaring college costs. As tuition has risen and state support has dwindled, federally-guaranteed loans has stepped in to cover the gap. It would be incorrect to say that colleges charge more because there are more loans out there, rather, they charge what the market will bear.

        4.) Most undergraduate science majors _do not_ go into scientific research after graduation–you generally need a Masters or Ph.D. for that. The vast majority of liberal arts majors don’t work in their fields either (again, you need a post-graduate degree for that). Yes, engineers do useful work society doesn’t need more lawyers, many doctors go into prestige practices rather than “necessary” fields, and its debatable whether financiers do anything of inherent value for society. Which path, STEM or Liberal Arts, is “better for society?” That’s an exceedingly difficult question to ask. We are a society whose technological ability has far outstripped our ethical acumen, and that is a dangerous circumstance indeed. Perhaps we could use a few more historians and philosophers, and a few less lawyers and businessmen. But either way, students have their whole lives to do something useful for society, and hopefully they chose to do so rather than merely pursue fame, fortune, or the endless quest for materialistic reward. One could make the argument that a liberal arts degree provides a better foundation to determine what that good might actually be. Engineering and science discoveries don’t actually improve society on their own, their employment for the betterment of all does. And those decisions as to utilization are not made by engineers and scientists.
        Mostly, these days, their discoveries are marketized and turn into products. Look at big pharma, for example, artificially inflating the price of life-saving drugs to pull in massive profits.

        Einstein had it right, “the unleashed power of the atom has changed everything except our thinking. Thus, we are drifting toward catastrophe beyond conception. We shall require a substantially new manner of thinking if mankind is to survive.” From where, if not from the liberal arts, will that “new manner of thinking” come? I sincerely doubt it will be from an MBA program at Wharton. But hey, it could do, and I’ll pay $99.99 in ten easy instalments if it does!

        • kj

          ” It would be incorrect to say that colleges charge more because there are more loans out there, rather, they charge what the market will bear.” It’s not incorrect at all. The “market” will bear more when other people are paying the bills.

          • Glen_S_McGhee_FHEAP

            Right, but then “other people” have entered the market too; they have become part of the “market.”

          • kj

            What lender would not like to be part of a “market” wherein the government protects him from losses?

          • Glen_S_McGhee_FHEAP

            Yes, exactly right.
            Saw this on Pareto, the Italian intellectual, with some great quotes.
            https://www.goodreads.com/review/show/2037823532

    • Glen_S_McGhee_FHEAP

      Well, a bigger problem with a post-ISA world is that it exacerbates income inequities by sponsoring students studying in the major de jour. In other words, even if the program worked as intended, the social structural outcomes directly feed into increasing stratification, more have-nots with less.
      Corporations would love this kind of thing, as with similar programs, they would benefit by using the participants as interns and employees.

      Yes, I am certain there would also be psychological and cognitive issues, sponsorship-ideologies being imprinted on the students. I suppose the opportunity to impress millennials is one of the major attractions.

    • kj

      The current tuition rates have absolutely nothing to do with a healthy, free market.

    • AtlanticReader5

      If you want to study something you have passion for, go for it! As you said, they end up earning more anyways. The real student loan crisis is largely students who just can’t cut it and graduate (or not) from low quality schools with mountains of debt.

      High tuition is a combination of price discrimination (Harvard can get $60k/year out of a rich kid but $10k/year from a poor kid) and heavy subsidies (if the government gives the poor kid $20k/year in scholarships and loans, Harvard just increases tuition for everyone to capture some of the money)

  • Rob Jenkins

    Attending a local community college would likely NOT be the equivalent of repeating high school. In most states, CCs have articulation agreements with the university system such that the courses their students take are the exact same courses they would take at the university–mostly, required core courses and pre-reqs for majors. As for rigor, many of those courses at the university would be taught by inexperienced grad students, whereas at the CC, those same courses are often taught by veteran professors. Perhaps that’s why many studies show that students who transfer from a CC to a university typically do as well as or better than the students who started at the university–and why nearly half of all four-year grads attended a CC at some point.

    • Glen_S_McGhee_FHEAP

      Yes. I agree that “spending two years there would be an educational waste of time since the coursework would be like repeating high school” is completely wrong. Please show me high school graduates that can walk into a CC differential equations course and succeed! DE is central to engineering and physics.

      More to the point — why force STEM students to take useless “liberal arts” courses? Why is it taboo in higher learning to focus solely on “hard” sciences? Tremendous waste of time and money for those better suited for mathematics and sciences, if they so desire and can endure the ordeal.

      My undergraduate years spanned the spectrum, math, physics, literature, and philosophy, as a way of rewarding myself while I earned a BS (double major in Math and Philosophy, minor in English). Still — sadly, my hard won math degree proved worthless. Same for my elite professional degree.

      • DrOfnothing

        Glen, I am very surprised and disappointed to hear you say that there is no intrinsic value in studying and understanding history, literature, philosophy, languages, and the arts. Why are these “useless courses ” and a “tremendous waste of time?” If the goal of education is produce informed citizens of the republic rather than just economically productive cogs in the great wheels of our military-industrial-scientific machine, then knowledge of these fields is essential–it’s what makes it education, rather than just an advanced form of vocational training. If we had a better secondary education system, as most Western countries do, this would be less important. But most students can make it through high school with only a paltry understanding of the subjects they encounter. And in college, a significant number of students who study science don’t go into science (much like yourself) but they all vote (hopefully) and contribute in some way to public discourse. STEM knowledge, for all its utility, offers next to nothing in the way of social perspective, making informed political choices, the nature of human existence, ethics and morality, and a whole host of other elements that rest at the core of who we are as human beings living in society. Think of how much more substantive our current political debates would be if the average viewer had a more critical engagement and historical perspective on Trump’s outrageously inaccurate claims about history, politics, international relations, economics, etc. I certainly see the benefit of your Philosophy and English courses in our discussions here!

        • Glen_S_McGhee_FHEAP

          Actually, I once spoke with a non-degreed LPN here in Florida about credential creep, how the hospitals want only nurses with bachelors degrees, and she complained: What was the value in going back for courses in geography? Why pay nurses with a degree more? She complained that she studied nursing because she wanted to be a nurse, and is now being penalized. She saw this all as a complete waste of time (probably very expensive, too).

          Her logic can be extended to a select population. That’s my point.

          “If the goal of education is produce informed citizens of the republic rather than just economically productive cogs in the great wheels of our military-industrial-scientific machine …”

          Does education produce informed citizens of the republic?

          • kj

            As to your rhetorical question at the end, one could argue an inverse relationship between education and an informed citizen, in many situations.

          • Glen_S_McGhee_FHEAP

            Ha! Okay, I’ll go with that!

    • kj

      They also might tend to do better because they didn’t spend their first two years partying.

  • JWJ

    Certainly the ISA is an interesting concept and should be given a try. Don’t see how it works with ISA not being dischargeable in bankruptcy. Is there any non-govt related debt that is not dischargeable in bankruptcy (outside of child support)? Would the ISA funder be able to access tax refunds or would they only be able to collect via harassing phone calls?

    The key item to get a handle on is the EXPENSE side. That is where the problem of student loan debt has come from.

    At UNC, tuition+fees have gone up almost by a factor of 5 (in inflation adjusted dollars) since the mid 1980’s (I chose then because that is when the increase in costs curve definitely starts to have a steeper slope). In 1985, tuition+fees were about $1,800 per year (inflation adjusted). This year, about $8,800.
    Room and board back in the mid 1980’s was about $6,300 (inflation adjusted), compared to $11,500 now.
    So the combined annual costs (excluding books and personal) has gone from $8,100 (inflation adjusted) in the mid 1980s to about $20,000. More than double.

    Number of UNC-CH employees increased by 85% (7,600 noses to 12,400 noses) since the mid 80s, the student population only increased by about 35%. Most of that employee increase was non-teaching staff. If the proportion of employees only grew by the same percentage as the increase in students, there would be at least around $250m to $350M decrease in annual operating costs.

    The amount of real estate went up by 125% (8.8M square feet to 19.9M square feet) . That is a lot of facilities cost increase for a 35% increase in students.

    Endowment has gone from $181M (inflation adjusted ) to $2.6BILLION.

    And for the ignorant who attempt to blame a decrease in North Carolina taxpayer funding, the amount coming from taxpayers increased from about $415M in the mid 80s (inflation adjusted) to about $500M. While not a large increase in about 20% in real dollars, still NOT a cut. Now of course, it is reduction in per student funding, but certainly good management should be able realize some economies of scale.

    So to get rid of the mountain of college debt, get the annual cost of attending UNC (room, board, tuition+fees) back down to $8,100 (inflation adjusted), as it was in 1985.

    • kj

      You make some very good points, with relevant data. A couple of thoughts: 1) easy money available to students almost guarantees colleges will find a way to increase costs, 2) Hyper regulation and leftist goofiness programs add immensely to the cost of college.

  • AtlanticReader5

    Two parents earning $50k/year with one child pay $4.5k/year for that child to attend Harvard. If that’s not affordable I don’t know what is.

    • JWJ

      I saw figures of 0-10% of total income between $60K to $150K income for the parents. In your example, the possible amount could be up to $10K per year at Harvard (that amounts INCLUDES Housing and Food).

      Realistically, the number of high school graduates from $100K (plus or minus 10%) households that apply to Harvard that actually GET INTO Harvard is probably around 100 per year. So banking on getting into Harvard is a pretty low proposition.

      More likely, is somewhere in the UNC System. Now what would you think that same kid coming from a $100K household would have to pay per year (including housing and food) to go to UNC-Wilimington, App State, ECU, UNC-CH, Charlotte, Greensboro, or NC State? My guess would be around $12K to $16K per year. That would still mean around $40K-$50K of debt upon graduation.

      What do you think?

      • AtlanticReader5

        http://features.thecrimson.com/2016/freshman-survey/makeup/

        40% of the Harvard incoming class comes from families earning under $125k. 15% comes from families earning under $40k. Harvard’s class of 2020 is about 2000 students, so based on the %s above about 500-700 students from that income range will get into Harvard.

        And anyway back to the original point – Harvard is very affordable to those with low incomes. It is obviously hard to get in because Harvard is one of the most selective institutions in the country.

        $40k – $50k of debt vs. the supposed lifetime earnings increase of $1 million+ for college graduates seems like a pretty good deal. The problem is if the earnings increases don’t materialize because college isn’t a good investment for that student.

        • JWJ

          Thanks for the response and the link.