American higher education costs too much, delivers too little value, and has saddled an entire generation with debt they cannot escape. Everyone agrees that there is a problem, but interlocking incentives for those benefiting from the current system have derailed meaningful solutions to the problem. Progressives want to make college tuition free through state subsidies or debt forgiveness, conservatives see that as a reward for irresponsible student borrowing and would rather cut bloated college budgets and departments. The conflict between these approaches has yielded more heat than light and resulted in little progress in making higher education more useful and affordable for students. It’s time to make some simple reforms that reduce government involvement to better align the incentives of students, schools, and lenders.
How Did We Get Here?
In early America, institutions of higher education were endowed by the states, churches, or philanthropists. Most people were employed in farming, skilled trades, or as laborers. Pursuing a college education was for an elite few who wanted to be doctors, lawyers, or study the arts and sciences. Improving American higher education was a priority for the founders, who understood its importance to the success of a nascent country. Thomas Jefferson was so dedicated to education that his tombstone at Monticello includes “father of the University of Virginia” but omits President of the United States. Priorities.
As the country expanded, states provided grants of land to universities, both for use as a campus and also as an endowment to provide a base of financial support for the university to operate in perpetuity. This paralleled the endowments of private institutions by philanthropists, but was meant to achieve the same purpose of providing a solid financial base for higher education.
The first major Federal government intervention in higher education was the Servicemen’s Readjustment Act of 1944, commonly known as the G.I. Bill, which subsidized college education for returning veterans of World War II. Rather than returning to agriculture or the trades after their military service, many veterans took advantage of a free ticket to get a college degree at a time when college degrees were still rare.
After that wave of funding and enrollment, the next big Federal government intervention was the Higher Education Act of 1965, which created various grants and loan programs to subsidize higher education through the Department of Education. The Pell Grant (originally called the Basic Educational Opportunity Grant), designed to provide support for a basic college education for economically disadvantaged students. This program is administered by the Department of Education and requires the student to complete the Free Application for Federal Student Aid (FAFSA), which centralizes the application process and has the Federal government involved in the vast majority of students pursuing higher education. The FAFSA is also used to apply for federally guaranteed student loans like Stafford loans.
After the September 11 attack in 2001, Congress passed the Post 9/11 GI Bill, which significantly expanded the financial benefits for veterans who served after 9/11. In addition to tuition, it provides moving and housing expenses for veterans seeking higher education.
In 2009, the American Opportunity Tax Credit provided a partially refundable tax credit of up to $2,500 per individual for qualifying higher education expenses. This was an expansion on the previous Hope Tax Credit that was for up to $1,200 of qualifying educational expenses.
In the 2020 election, some candidates ran on the promise of free college tuition for every American student, while others promised the cancellation of student loan debt to win votes. While the winning candidate did not make such promises, expect to see these ideas pushed in the upcoming Congress.
Every one of these government interventions into higher education were intended to make education more affordable for people who would otherwise not be able to afford or access higher education. There is no question that subsidized loans, grants, tax credits, and a simplified financial aid application all have increased the number of people using higher education, but they have also inflated the cost of higher education and provided an incentive for predatory education providers to target the people receiving the benefits with aggressive advertising, including veterans and low income students.
There is a simple pattern: Some people can’t afford higher education. The government intervenes to give them money to afford higher education. Because the government is providing more money, the government applies more regulation. The schools charge more for higher education due to inflation from the subsidies and the cost of more regulation. This creates a new group of people who can’t afford higher education.
Wash. Rinse. Repeat.
What Can We Do to Fix It?
Higher education is a huge industry in our society, one with many different players, different interests, and lots of moving parts. That has made it easy for politicians to alternate between throwing taxpayer money at the problem and doing nothing because the system is too complex. It doesn’t help that the current distorted higher education system is working very well for everyone other than the students. Students aren’t a politically powerful group, while the banks and educational institutions are. To make progress on this problem, we need to change the incentive structure and break out of the cycle of inflation.
Apply Bankruptcy Laws Equally
“We support ending federal student loan guarantees and special treatment of student loan debt in bankruptcy proceedings.”Libertarian Party Platform
Let’s say a student goes off to college, signs up for a high interest credit card, finances an overpriced car, takes out student loans to pay for school, and has massive hospital bills for treating broken bones from a car accident. After they graduate, they don’t make enough money to pay back those debts, what can they do?
Bankruptcy protections allow someone who is unable to repay their debts to seek a discharge of those debts in order to get a fresh start. It doesn’t matter if it’s credit card debt, auto debt, or medical debt; if you meet the requirements of the bankruptcy statute, all of those debts can be completely discharged. There is one kind of debt that is not dischargeable in bankruptcy: student loan debt. It’s the only debt our student will be stuck with after the bankruptcy.
This exclusion has been a windfall for the financial institutions that provide student loans, since the loans are not only guaranteed by the Federal government if a student defaults, but they can continue to try to collect on them as long as the student is alive. This has created a bubble of student loan debt that is over $1.6 trillion dollars and is estimated to be responsible for 20% of the decline in homeownership among 18-35 year-olds.
Why not just forgive all the student loans?
There’s a simplicity to just wiping the slate clean and popping the massive bubble and it’s very attractive to those of us carrying significant student loan debt. And while it would improve the situation for current borrowers, if the incentives don’t change, the same problems will reappear. Similar to Ronald Reagan’s amnesty for undocumented immigrants, it solves the current crisis but is no substitute for comprehensive reform.
When faced with the suggestion to forgive student loans, the better solution is to allow those loans to be discharged in bankruptcy for two main reasons:
- It is a remedy that will only be used by those people who are so unable to pay their debts that they would go through the bankruptcy process, not give the benefit to every person with student loan debt regardless of ability to pay.
- It is a standard that would reduce reckless lending in the future because the debt would be eligible for discharge if the debtor declared bankruptcy.
Eliminating the student loan debt exception from the bankruptcy code would allow students who got in over their heads the fresh start without providing a windfall to those borrowers who are able to repay their loans. It leverages the existing bankruptcy system rather than creating a new means test under the auspices of the Department of Education and applies one rule widely and equally instead of adding complexity to an already complex system.
As loans are discharged, it will provide data as to which schools are providing value for the tuition and which ones are focusing on slick marketing or fancy amenities that don’t provide long-term earning potential. Lenders who provide student loans can adjust rates and availability based on the likelihood a student will be able to repay the loan, instead of lending to people with little prospect of repayment because they know that the debt can’t be discharged. Prospective students can find out how many students from a school go on to repay their loans to make better educational choices.
It also forces the issue of Federal guarantees for student loans. If every student loan, no matter how large or risky, is backed by the full faith and credit of the Federal government, there is no reason for a lender not to loan as much money as possible. It’s free money, or as the economists put it, a moral hazard.
Free the Education Market
Government approved education is heavily subsidized and regulated. There are Federal, state, and local regulations that limit what schools can be started, what degrees they can provide, and how they can be run.
Some of these regulations are required in order for a student to be able to spend Federal grant or loan money at a school. This creates a powerful incentive for schools to comply with the regulations or lose the vast majority of educational financing. Outside a very few ideologically driven institutions like Hillsdale College and Bob Jones University, all American higher education institutions participate in the Federal financial aid system.
There is a strong incentive for existing educational institutions to prevent new competitors from entering the market. The associations of American law schools and medical schools work together and with the government to limit new schools from entering the market, by creating regulations that are unrelated to the educational outcome, but are very expensive, e.g. large physical libraries, residential campuses, and unnecessary administrative positions. Like Certificates of Need prior to allowing new hospitals to be constructed, it protects the power of existing institutions while hurting the consumer.
Higher education should serve the student, not the institution or the government. We should shift the focus in education regulation to the quality of outcomes for the students and graduates. Graduation, employment, and student loan repayment rates should be transparently available to prospective students to allow them to make an informed choice about where to spend their time and tuition.
“Only when the tide goes out do you discover who’s been swimming naked.”Warren Buffett
With an artificially limited market and all students having access to a base amount of financial aid, educational institutions have to find some way to justify costs that are increasing much faster than inflation, especially in those areas of study that don’t require laboratories or expensive equipment. For decades, that has been accomplished by providing gold-plated amenities like lounges, fitness centers, and dining options to enhance the educational “experience.” With in-person learning reduced or eliminated throughout the United States to mitigate the spread of COVID-19, there are no more network effects from being resident on campus, no more opportunities to take advantage of those amenities.
Stripping the provision of education down to the teaching has revealed which institutions have maintained educational quality and which ones were focusing outside the core mission of education. If more than half of a student’s tuition goes to non-teaching functions, that system is not sustainable.
Allow Innovative Educational Financing
The primary driver of the inflation and collapse of the mortgage bubble was the decoupling of risk and reward. Mortgage brokers were paid for originating a loan, but the broker didn’t hold the mortgage or suffer any consequence if the loan could not be repaid. The originating bank packed the mortgages into securities so that they also didn’t carry the bad loan on their books. There was no incentive to underwrite good loans because there was no cost for underwriting bad ones. Incentives matter.
The student loan bubble has been created in the same way. The primary goal of recruiters is to sign up students who can bring their financial aid to the school. Whether the student succeeds doesn’t impact whether the recruiter or the school gets paid.
Allowing for innovative financing models that align the incentives with the student will improve outcomes and still provide financial support for institutions that provide real educational value. Requiring schools to fully or partially guarantee loans for students who fail to graduate or gain employment after graduation would create an incentive to help students succeed academically and professionally after graduation.
A partnership model where private investors or schools could invest in a student’s education in exchange for a capped share of the student’s earnings for some period after graduation would encourage those investors to work toward the student’s professional success for at least the repayment period. The government already does this with military and public health scholarships for physicians that require a period of service after graduation as repayment. It would also encourage investment in those students and fields of study that are most likely to lead to success.
“If you’re not paying for it, you’re not the customer, you’re the product being sold.”
Republicans and Democrats don’t disagree on giving handouts of Federal money, they just disagree on who receives them. Democrats want to give them to students, Republicans want to give them to the banks that underwrite student loans, and the schools don’t care because they get the money either way. Schools, governments, and banks all have clear incentives in this system to get students who bring financial aid into their school. Student preferences or goals are an afterthought, if considered at all.
Providing an opportunity for debt relief through the bankruptcy system, expanding the variety of educational options to include those that refocus on competency instead of credentials, and innovative ways to finance education without the government will go a long way to empowering students and lead to a flourishing country.
Two Decades of Change in Federal and State Higher Education Funding – The Pew Charitable Trusts
National Center for Education Statistics – Department of Education