Economics, Pethokoukis

Thomas Sargent, incentives, and student loan forgiveness

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My AEI colleague Mark Perry recently posted a brief 2007 speech given by Nobel economist Thomas Sargent to graduates of Cal-Berkeley. It’s basically a dozen economic observations. Here is No. 4: “Everyone responds to incentives, including people you want to help. That is why social safety nets don’t always end up working as intended.”

That observation provides a useful lens through which to examine news, via the Wall Street Journal, that enrollment in plans providing college student debt forgiveness “has surged nearly 40% in just six months, to include at least 1.3 million Americans owing around $72 billion, U.S. Education Department records show.” And those numbers are headed higher.

Remember, everybody responds to incentives. And it doesn’t take a Nobel economist that maybe, just maybe, students and schools might pay even less attention to costs if debt can be forgiven. As it is, according to the WSJ, federal data show tuition and fees are up more than 6% a year on average in the past decade, more than 2 1/2  times inflation. And between 1982 and 2013, published tuition and fees at public four-year colleges nearly quadrupled in real terms. As AEI’s Andrew Kelly predicted back in 2012, ” … barring some sudden leveling off in college prices or significant growth in incomes, the costs of loan forgiveness will grow.”

So let’s change the incentives. If a student defaults on a loan, require the college to cover some share of that amount. Both parties should take into account the potential return on investment of school and major choices. (Better data is a necessity here.) Beyond that, how about diversifying the way students can pay for college? Last week two Republicans, Sen. Marco Rubio and Rep. Tom Petri, introduced legislation that would set basic standards for income-share agreements. Kelly describes ISAs in a WSJ op-ed he co-wrote about the Rubio-Petri plan:

Enter income-share agreements ( ISAs ), which are essentially equity instruments for human capital. Investors finance a student’s college education in return for a percentage of their future income over a fixed period. ISAs are not loans and there is no outstanding balance. If students earn more than expected, they will pay more, but they also will pay less—or nothing—if their earnings do not materialize.

The growth of ISAs would create more educational opportunity and reduce risk for students pursuing higher education. ISAs make financing available to students regardless of background without a government guarantee or subsidy. They would also alert students to high-quality, low-cost programs, as investors will offer the most favorable terms for programs with a reasonable price tag that help graduates succeed in the workplace. This, over time, could curb tuition inflation, and lower the cost of college. But most significantly, ISAs protect students from the severe downside risk of traditional student loans. …

In Oregon, state legislators in 2013 introduced a “Pay it Forward” plan that would allow students to attend public colleges tuition-free in exchange for 3% of their income after graduation. During the past decade, a handful of organizations have sprouted up to unite investors and students. For-profit groups such as Lumni, Pave and Upstart, as well as nonprofits including 13th Avenue, currently finance students through ISAs.


Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

3 thoughts on “Thomas Sargent, incentives, and student loan forgiveness

  1. If my memory serves me, in the 1970s Yale instituted a student loan program where repayment was tied to income. It was an utter bust.

  2. That model is indentured servitude unless there is a non-negotiable end date. Even communities could invest in successful graduates accepted to schools to fund projects, playgrounds and the like. Allows brain drain to still benefit small towns. Who would let down their community on purpose?

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