If you pay attention to student assistance, you know about income-contingent loans. And if you’ve heard about income-contingent loans, you probably know that the first national scheme debuted in Australia back in the late 1980s. You might even know that the first theoretical exploration of income-contingent loans was made by Milton Friedman back in the 1950s (actually, he was talking more about human-capital contracts, but close enough. And you might occasionally wonder: why did it take 30 years to go from idea to implementation? Well, the answer is that it didn’t: there was an intermediate stage in which a couple of universities tried to run their own income-contingent loan programs.
The year is 1971. Private 4-year universities were probably at their lowest-ever ebb relative to the big public flagships: massive amounts of public money had been pouring into public universities while privates had yet to really perfect their practice of extracting mega-millions from loaded donors. But Inflation is starting to rise in America as a result of a decade worth of a guns AND butter fiscal policy. And so schools like Yale began to think about raising tuition to meet higher costs and regain their place at the top of the academic dog-heap.
Enter economist James Tobin – a man who within a decade would win a Nobel Prize and is today mostly known for his advocacy of a beloved-of-the-left tax on financial transactions (the eponymous “Tobin Tax”). Room and board at Yale College at the time was $3,900 (yes, I know, I know). The university wanted to raise fees by about $1500 over the next five years, and so President Kingman Brewster (the model for Walden University’s President King in the comic strip Doonesbury) asked Tobin to come up with a scheme that would allow the institution raise said money without putting too much stress on students.
The result was something called the Yale Tuition Postponement Option. Students could choose to defer part of their tuition (the part that came on top of the pre-1971 $3,900) until after graduation. Repayment was a function of both loan balance and income: borrowers were required to repay 0.4% of their income for every $1,000 of tuition postponed (a minimum payment of $29/month was set). Repayments could take as long as 35 years although it was expected to take less time than that.
There was a catch, though. Loan programs lose money through defaults. These either have to be made up through subsidy (which is what happens in most government student loan programs) or mutual insurance among borrowers. Yale had no intention of subsidizing these loans, and so went the latter route. These were therefore in effect group loans – you kept paying until your entire borrowing cohort had repaid. You could escape this only by paying 150% of your initial loan and accrued interest.
You can imagine how this went. A lot of students borrowed, but there was a fair bit of adverse selection (people who worried about their incomes opted-in, people who thought they would earn a lot opted-out). And as time went on, a lot of graduates groused about subsidizing their less-successful classmates. The program was phased out in 1977-78 because federal student aid was becoming more generous and because the university was starting to twig to both the problem of adverse-selection program and the problem of keeping in contact with graduates and getting them to voluntarily disclose their incomes. Eventually, amidst rising alumni discontent, the program was wound up in 2001 and outstanding debts assumed by the University (which by this time could easily afford to do so).
The failure of the Yale Plan was certainly one reason why people were scared off income-contingency for another decade or so, until a reformist Australian government picked up the idea again in the late 1980s. But from a policy perspective it was not a total loss. One Yale student who enrolled in the program – fellow by the name of Clinton – thought it was a great idea. He made it a center-piece of his 1992 election campaign, and an income-contingent tuition option was in place by 1994. That specific policy never took off, but most of the income-based repayment plans (which are now used by 40% of all borrowers) owe their start to this program.
So, a failure for Yale perhaps. But a long-term win for American students.