Thursday, September 1, 2011

Are income-contingent loans for higher education feasible?

There is considerable discussion, in particular in the UK, about making education loans contingent on realized income after completion of education (and those who do not graduate have the loan paid by general taxes). On the face of it, it makes much sense as those who reap the most benefits from their education pay the most for it. But the bigger advantage is thought to come that such a scheme would help overcome risk-aversion, educational outcomes are risky after all, and thus help more people to get higher education. Also, because education then does not require upfront payments, it helps alleviate liquidity problems young people typically face.

Elena del Rey and María Racionero see that this is not that easy to implement. Indeed, some people would lose if such loans would be implemented, foremost those who do not need loans (but this can be reversed if they are very risk averse) and those who are little risk averse. Regarding education subsidized from general taxation, those who can afford private education are again opposed, as well as those who are less able to acquire higher education. If one were to choose between the two financing schemes, it would all depend on the political power. If we assume everyone has a vote of equal weight, then all boils down the level of risk aversion of the population, the distribution of which we know very little about, and the aptitude to education, which is rather uncertain at the individual level. So in the end, we are not much wiser.


Anonymous said...

take a look at the Australian HELP (formerly HECS) system. The government provides a loan, which is indexed at inflation. Then, once a student has graduated, the loan is repaid via the tax system, with the rate of repayments depending on the amount of income (from memory, repayments start at 3% of your income above $35000 and rise 1% for every 10 or 15k). For anyone who does not wish to take advantage of the loan system, upfront payments may be made (which also attract a 15 or 20% discount).

Anonymous said...

Yale experimented with this and it was plagued by classic asymmetrical information problems. Individuals have a better idea of their potential incomes than the individual giving the loan, so if loan repayment is based upon how much you make, people will sort into the loan program which makes maximizes their after loan repayment earnings.

Individuals with higher earning potential will seek loans with fixed terms. Individuals with lower earning potential will seek loans that are income-contingent.

It's not an optimal program unless individuals have poor perceptions of future earnings potential.

Kansan said...

MyRichUncle used to provide student loans whose size depended on the grades and the major of the student. The concept was brilliant, but the company failed during the credit crisis when funds dried up.

mOOm said...

Yes, I was surprised by this post, because I thought we had those here in Australia.