HESA

Higher Education Strategy Associates

Category Archives: student debt

March 18

How ICRs can Become Graduate Taxes: The Case of England

As noted yesterday, graduate taxes and income-contingent loans have many similar features.  They both defer payments until after graduation, and they are usually payable as a percentage of marginal income above a given threshold.  In England right now, the payment scheme on ICR loans is that students pay 9% of whatever income they earn over £21,000 (roughly C$38,000).  The difference between the two is that with a loan you have a set amount to pay, and when it’s paid you’re finished.  With a graduate tax there is no principal, so you just keeping paying that fraction of your income for as long as the tax lasts.

That sounds like a simple and clear delineation, right?  Well, here’s a twist: what if the loan were so big that you had no practical chance of ever paying it off at the set repayment rate?  What would the difference between an ICR and a grad tax be then?  The answer is: practically nothing – and that’s exactly where England finds itself right now.

Let’s step back a bit: in 2010, the UK government decided to let institutions charge tuition up to £9000.  They also decided to allow students to borrow this amount for tuition (plus more, again, for living expenses) under the repayment scheme described above.  When they did this, they were under the misapprehension that universities might actually try to compete for students on price, and hence assumed an average tuition of about £7000.  Rather predictably, average tuition shot straight to £8500.  As a result, it’s quite common for students to be borrowing £12-13,000 per year, or £36-39,000 for a degree (that’s C$66-72,000 – yes, really).

Crazy, right?  Cue all the “intolerable debt burden” stuff.  But wait: these loans aren’t like the ones we’re used to.  Repayment is based on your income rather than size of debt – no graduate is ever required to pay more than 9% of their income over £21,000 in any given year, so the burden in any given year is pretty limited.  And – here’s the kicker – the loan gets forgiven after 30 years.  So, if you don’t finish paying, your obligation disappears without you having any debt overhang. Exactly like a Graduate Tax.

How many won’t pay it off?  Well, these things are difficult to predict, but even over 30 years, paying 9% of your income over $38,000 isn’t likely to completely pay off very many of these loans.  The government’s own financial forecasts are that 35-40% of the total net present value of the loans will have to be forgiven (others put it 8-10% higher).  At a rough estimate, that probably means 70 to 80% of all borrowers will see some loan forgiveness.

At this point you start to wonder if debt numbers really matter in this system.  Forget ICR: for most people, the current system is simply one in which government transfers billions of pounds in 2014 to institutions using student loans as a kind of voucher system, then turns a portion of those loans into student grants in 2044 via loan forgiveness.  In the meantime, graduates pay a 9% surtax on income over £21,000.

Altogether, a very wacky system.  Not a model for anyone, really.

March 17

Oregon’s “Pay It Forward” Scheme and the ICR vs. Graduate Tax Problem

You may have heard some rumblings from south of the border over the past few months with respect to a program called Pay It Forward (PIF).  The brainchild of a student group called Students for Educational Debt Reform, this idea was picked up by the Oregon assembly last summer; within a few months, over a dozen state governments were examining similar draft legislation.

The basics of the program are these: instead of paying tuition, students agree to pay a percentage of their future income (the percentages vary by state – in Oregon it’s 0.75% per year of study) for 20 years after graduation.  Some people mistook this for a version of income-contingent loans because it emphasized paying for school after-the-fact rather than up-front, and also because repayments were to be made as a function of income.  But there’s one key difference.  Loans have a limited liability: once you pay off the principal and interest, you’re done.  With PIF, there is no principal – once you start paying into a hypothecated fund, destined for the state’s higher education institutions, you keep on paying for 20 years no matter what.  This is formally known as a “graduate tax”.

Graduate taxes tend to be more progressive than income-contingent loans.  If you’re at the bottom of the income scale, you probably come out better off – you simply never pay anything.  If you’re at the top of the income scale, you’re likely going to pay a lot more because a portion of your income will go into public coffers long after you’d likely have paid off a loan.  Interestingly, the famous Yale Tuition Postponement Option of the early 1970s (designed by Nobellist James Tobin, and used by Bill Clinton when he attended law school there) went off the rails for precisely this reason – the richer students got tired of paying for the poorer ones, and started making a fuss.

One downside to a graduate tax is that it’s harder to collect than a loan.  In the US, for instance, it’s hard to imagine enforcing something like PIF, unless it was instituted nationally (if someone moved from Portland to Chicago, would Illinois be responsible for collecting the PIF contribution?).  A graduate tax was in fact examined relatively thoroughly not once but twice in England (the 1997 Dearing Report and the 2005 fee reform), and was rejected precisely because of concerns about grads evading repayment through emigration.

Another downside is: where exactly does the money come from while you’re waiting for graduates to start earning money?  If tuition is covering 40% of institutional expenditure, someone has to make that income good over the 20 or so years before the grad tax makes up the difference.  It’s not clear who that might be; if the state had money to do this, it probably wouldn’t be faffing around with ideas like PIF.  You could securitize the revenue stream, of course, but that also might get tricky.  Income-contingent loans lack graduate taxes’ most potentially progressive features, but they do have the advantage of: a) being collectable, and b) producing income for institutions in the short term.

There is of course one country that is trying very hard to merge the ideas of ICR and graduate taxes, with some really odd results.  More on the English experiment tomorrow.

February 27

New Student Debt Numbers

So, the more stat-minded among you may have noted the release, this past Tuesday, of Statistics Canada’s 2012 Survey of Financial Security (SFS).  Though the main talking points were largely about mortgage debt, it also contained some interesting statistics on student debt.

Now, remember that these are figures on outstanding student debt.  Some of it will be in repayment (i.e. held by graduates now in the labour force), and some of it will not (i.e. held by current students).  The way to think of these debt figures is as a collective portrait of people who borrowed in the decade or so prior to the snapshot, and who had not yet fully repaid their debt (because those who had successfully completed repayment would be out of the sample).  So the 2012 figure for student debt is actually a collective picture of the outstanding debt of everyone who borrowed in the period 2002-2012, and who had not yet repaid, the 2005 figure covers the period 1995-2005 or so, etc., etc.

Anyways, the headline that the usual suspects would like you to focus on is the one about aggregate debt outstanding: $28 billion, up by $5.5 billion (23%) in real dollars since the last time the study was conducted, in 2005.  Why is that a big deal?  Because!  $28 Billion!  Big Number!  But a slightly more intelligent look at the data shows a different story.

Figure 1 shows that the average outstanding student loan was about $15,000.  That’s up about 6% from 2005, and 13% from 1999 (again, all figures are inflation-adjusted).  Why is this figure so much smaller than the one for total debt?  Simple: more people have outstanding student debt than in 2005, so it’s divided among a larger population.  That might be because people are taking longer to repay their loans – more likely, though, it’s a reflection of the fact that student numbers as a whole rose substantially over the 00s.

Figure 1 – Average Student Debt Among Holders of Outstanding Student Loans, in $2012

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Intriguingly, the data for median student debt (that is, the mid-point value, rather than the mean) tells a slightly different story, in that it fell 2% between 2005 and 2012 (though it has still risen a bit since 1999).

Figure 2 – Median Student Debt Among Holders of Outstanding Student Loans, in $2012

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How should we interpret this?  This isn’t the easiest data to unpack.  It probably means, as I pointed out back here, that student debt hasn’t been increasing.  But it also might mean that debt repayment rates have been increasing along with indebtedness, or (less likely) that a greater fraction of student loans are held by individuals who graduated from shorter programs.

Whatever the truth, what we do know for sure is that young people aren’t drowning in student loan debt.  Among family units headed by people under-35, only a quarter hold a student loan, and the loan debt constitutes just 5.3% of their total debt, down from 6.7% in 2005.  Whatever the effects of student borrowing is, it would appear that deterring graduates from taking on ever-larger mortgages isn’t one of them.

January 29

Why is Student Debt Not Increasing?

Yesterday, we discussed why student debt burdens were falling.  One of the key ingredients in that recipe was that student debt had remained stable, or even fallen, over the last decade or so.  This is a puzzling piece for many because it seems counterintuitive.  So what’s going on?

Well, costs are increasing, but only modestly so: since 2000, tuition has only been rising about 2% above inflation.  There’s been no real change in the percentage of students living away from home – and for those who do live away from home, the picture is mixed: students in Western Canada are paying a lot more than they did 10 years ago; students in Ontario, on the whole, tend to be paying less.  Nationally, it mostly evens out.  Given these changes in costs, one would expect modest but noticeable increases in borrowing, ceteris paribus.  So something else must have changed in order to offset this.  But what?

Is it a question of students themselves having more resources?  Probably not.  As Figure 1 shows, student employment is remarkably stable over time.   So, too, is their average hourly income from wages, which surveys show is almost always 20-30% above minimum wage.

Figure 1: Student Employment Patterns, Canada, 1997-8 to 2009-10

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What about money from parents?  This seems to be up a little bit: average transfer in 2001-2 was about $2000 (in $2011), and is now about $2500.  What has changed, however, is the amount of money students get through RESPs.  This was negligible ten years ago; now, roughly 30% of students receive money from this source, and it’s a significant amount, too ($4,000/year, on average).  Obviously, much of that’s going to students who aren’t on student aid, but for those who are, it’s more than enough to explain the slowing rise in debt.

Then there’s the rise in student assistance.  Institutions have massively increased their scholarship budgets.  In the 1990s, about one in three new students got some kind of entrance scholarship.  Now it’s two in three.  The total amount spent on grants and remissions by provincial and federal governments jumped from $600 million/year in 1995, to almost $1.8 billion in 2010 (both figures in $2011 real dollars).  And of course, governments have added an extra $1.5 billion in tax credits.  Not all of that ends up in students’ pockets (some ends up with parents, some gets deferred until after graduation), but enough does to take a bite out of rising costs.

Figure 2: Increases in Total Government Student Assistance, Canada, 1993-94 to 2010-11 (in real $2011)

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None of these, on its own, amounts to a silver bullet to explain why student debt is stable or falling.  But together, it’s easy to see: more grants, more tax credits, the creation of the RESP are, together, probably putting about $3 billion extra into students’ hands every year.  Call it about $3,000 per year, per student.  Then add institutional aid, and throw in the extra billion or so that has gone to grad student funding in the past fifteen years.  That brings us to about $4,000 extra, per student.  That’s more than enough to explain why debt isn’t increasing.

In fact, the real question may be: why hasn’t it decreased more?

January 28

Why Student Debt Burden is Falling Like a Stone

Everyone talks about “rising student debt burdens” as if they are real.  But they’re not.  In fact, the burden of carrying a student loan has fallen significantly over the past decade.

Student loan burden is best measured by looking at the percentage of monthly after-tax income that it takes to service a loan each month.  This figure will therefore be affected by four different factors, namely: the size of student loan debt, interest rates, post-graduation income, and taxes.  Here’s what’s happened to each of those over the past 25 years:

1)      Student debt rose very quickly in the 1990s, more than doubling between 1992 and 2000.  This was because the federal government raised lending limits, and provinces by-and-large cut their grants programs.  Starting in the early 2000s, however (for reasons I’ll get into tomorrow), growth in student borrowing stabilized.  As a result, student debt has been roughly constant in real terms for over a decade now, as I showed back here, and may even have decreased a bit.

2)      Interest rates.  Nobody remembers this, but during the early 1990s, when we had the triple-whammy of the peso crisis, the sovereignty crisis, and an inflation-obsessed John Crow as Governor of the Bank of Canada, our interest rates were regularly 400 basis points higher than the Americans’.  They’ve come way, way, way down.  In 1991, prime briefly hit 14%, and throughout the 90s it averaged about 7.5%.  Today it’s 3%.

3)      Post-Graduation Income has remained remarkably constant over time.  Between 1988 and 2005, it didn’t change a bit in real terms.  Growth has been below inflation in the last few years because of the long recession, but it is still growing in nominal terms (we know this thanks to the many provincial graduates surveys, which have replaced the NGS as our key source of data on this subject).

4)      Taxes.  They’re down a fair bit.  Someone with average graduate income, 2 years out of school, paid out 28% of their income in taxes in the early 90s; now they pay 22%. (Thanks to Kevin Milligan and his great CTaCS program for the help in calculating this.)

In other words, things were pretty bad in the 1990s.  But since then, most of the relevant forces that underpin student loan burden have been heading in the right direction: debt is stable, or even down a bit, interest rates are down, taxes are down, and until quite recently income was more or less stable – and even now isn’t down very much.  Put it all together and what you see is that the after-tax repayment burden for someone with average student wages, repaying an average-sized student loan, has fallen sharply in the last decade:

Figure 1: Percentage of Average After-tax Earnings of Graduates, 2 Years Out, Required to Service an Average Student Loan

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That’s right: the burden of carrying an average loan, with an average salary, has fallen by over a third in the past decade.  It’s actually back down to where it was in 1992, before the rapid rise in tuition and debt of the 1990s.

I no longer expect facts to get in the way of people trying to manufacture a good crisis, but if anyone does happen to care about the data, there you go.

January 20

Canada’s Income-Contingent Loan System

I see that yet another group has called for Canada to have an income-contingent Loan Program to help students fund their higher education studies.  Great idea.  In fact, it’s so great that the country adopted an income-contingent system five years ago. It’s just that nobody noticed.

Many people think that income-contingency requires that loan repayments be a fixed percentage of individual income, or that loan recovery be handled through the tax system.  While it’s true that some of the world’s more prominent examples of income-contingency (e.g. Australia, UK) have those features, those aren’t necessary characteristics of an income-contingent system.  All “income-contingent” means is that repayments to some degree reflect a borrower’s ability to repay.

Canada has had some element of income-contingency ever since the “Interest Relief” program was introduced in 1984.  Something of a misnomer, Interest Relief allowed unemployed borrowers in re-payment to suspend principal repayments for up to 18 months, during which time government would pay the interest on the loan.  The program was expanded in 1994 to include borrowers who were employed but had high debt service ratios.  In the 1998 Budget, the time limit went up to 30 (or in some cases 54) months.  That budget also announced a system whereby borrowers who didn’t quite meet the test for full interest-relief could get a partial subsidy – unfortunately, this system was never implemented, because the government, and the banks who administered the program at the time, couldn’t figure out how to make it work properly.  But the idea came back again in the 2008 Budget, with the introduction of RAP, which was basically the 1998 plan with some knobs added on.

So, like Australia and the UK, we have a system where borrowers with low-income pay nothing, and a system which phases in loan repayments gradually as borrowers begin to earn more money.  The only major difference between Canada and Australia/UK is that we say if you’re above a certain income level, you should be paying off a loan quickly under a normal system of amortization, whereas they say the hell with it, and just take a proportion of your income because it’s simpler to manage that way.

Why don’t we call it income-contingency?  Basically, it’s because no one wants to embarrass the Canadian Federation of Students (CFS).  For years, they insisted income-contingency was the work of Satan because in making loans easier to pay it paved the way for higher tuition fees (yes, really).  Yet, as the details of RAP were developed, they decided they quite liked it.  Since it’s rare CFS actually backs a government program, it was generally agreed that pointing out to them that that RAP was in fact income-contingency (which they still in theory strenuously oppose) would create unnecessary problems.

So there you go.  We have a reasonable student loan repayment system, which the main players like but no one else understands.  It’d be nice if we could find a way to communicate this to the country so we could stop with the inane demands for income-contingency, but c’est la vie.

October 31

Parents, Transfers, and Debt

A few weeks ago, CBC ran a story about parents taking on debt so that their kids didn’t have to.  It’s a story worth parsing carefully, because it’s a great example of how economically irrational people can be when it comes to debt.

One family in this story recounts shelling out $200,000 for their three kids to go to university.  They even went into debt themselves to do it.  But they wanted to do this, apparently, because they wanted their kids to have flexibility and freedom when they graduated.  This would allow their kids to take time to work out what they wanted to do, instead of being forced into work quickly.

Hmmmmmmm.

Let’s leave aside for the moment the question of why anyone would take on debt at commercial rates when your kids could borrow interest-free from a public loan program (though, let’s face it, that’s kind of nuts).  If the only thing you’re worried about is making sure your kids are making stress-free career decisions, then why not let the kid borrow the money, and then agree to assume the loan repayment for the first couple of years after graduation?  Or let the kid ease into repayment by gradually transferring the burden (25% in the first year, 50% in the second, etc.)?  It’s far cheaper, and doesn’t require the student to take on any burden until they’re ready. It should be a slam dunk, no?

The problem, I think, is that transferring money to your kids while they’re in school is socially acceptable in a way that paying for your kids debts is not.  It’s not simply a matter of pre-graduation = child, post-graduation = adult, and that gifts to children are more acceptable than gifts to adults; giving large sums of money to your kids still is acceptable even after graduation, as long as it’s attached to certain types of life events (e.g. marriage, buying a house, etc.).  Taking on debt, as David Graeber has pointed out, presupposes adulthood, since debts can only be incurred between legal equals.  And settling debts, making good on one’s obligations, is intrinsically connected to notions of virtue and honour.  Interfering with this – offering to make payments in a child’s stead – is in some ways seen as interfering in a rite of adulthood in a way that simply handing them money prior to graduation is not.  Effectively, it’s emasculating.

There are many culturally-rooted views about debt out there, and policy can’t be made to accommodate them all. Equally, though, there’s no reason to assume that, just because government comes up with economically “rational” policies, students and families will react to them in a “rational” way.  There’s way too many notions of innocence, duty, sin, and honour tied up with children assuming debt for the first time for that to be possible.

October 30

The Cultural Determinants of Student Debt Policy

With the school year now back in full swing, one of the things you’ve undoubtedly heard, and will continue to hear, is the question of student debt, and how it has become “out of control”.  And in that spirit, I wanted to relay a little anecdote.

A few months ago, as part of a student loans-related project that I was working on in a Southeast-Asian country, I led a session for government and bank officials looking at possible loan parameters, and their potential cost implications.  One of the parameters, obviously, was the repayment period of the loan.  In most of my sample models, I had assumed that the period would look something like Canada’s – about 10 years.  But in most of the models the participants developed, the period was only 4-6 years.

Shorter repayment periods on student loans are pretty common in Asia – in China, 4-6 years is also the norm. The policy implications of shorter periods are straightforward.  If the government is providing interest subsidies, then shorter repayment periods will reduce those subsidies; if not, then shorter repayment periods reduce the total amount of interest paid by students.  Either way, the shorter the period, the greater the repayment burden to students, as they must distribute the repayment of a given principal over a shorter period of time.

None of this was an issue for the participants, who just viewed debt as something young people had to repay quickly in order to get on with their lives.  When I pointed out that, in some cases, this would mean repayments would take up between a quarter and a third of graduates’ income, there were shrugs.  Borrowers were, for the most part, young and unmarried, participants said, they can just live at home and pay it off quickly.  What about getting married, I asked?  Or buying a car, or a house?  Almost unanimously, the reaction was: “pay this one down first, then borrow again if you need to”.

At this point it occurred to me that the entire narrative around student debt in the developed world is based on the notion that post-secondary graduates ought to immediately be able to join the middle-class, with all the consumption privileges that implies.  Data suggesting that graduates are putting off purchases because of student debt are treated as prima facie evidence that student loan debt is out of control.  In Asia, on the other hand, this might be considered a sign of policy success.

I am not saying the Asian way is right and ours is wrong.  I am just saying it’s worth understanding the cultural biases behind our own policies – and occasionally asking ourselves how much we want to pay to keep those biases intact.

October 29

How Student Debt Became a Big Deal in Canada

If you go back to debates in the 1993 election, or Lloyd Axworthy’s famous Social Security “Green Paper”,  most of what you see in the discourse about PSE would be pretty familiar today: “higher tuition = less access”, etc.  But what you wouldn’t find was any discussion of student debt.  It just wasn’t something anyone talked about.

Partly, this was because there wasn’t a lot of student debt at the time.  Although federal and provincial loans programs were undergoing a series of changes (increases in loan limits, cuts in grant programs), which set the stage for much higher student loan debt, no one was feeling it yet. But the more important reason was that no one understood how potent “debt” could be as a political argument.  And it wasn’t student groups who would stumble upon this realization – it was the Association of Universities and Colleges of Canada (AUCC).

In the mid-90s, AUCC had a simple mantra: the sector needed to speak with one voice.  No squabbling with CAUT or student groups – find a package of measures everyone can agree on.  In 1996-7, that unity of purpose on the research file resulted in the creation of the Canada Foundation for Innovation.  I was hired by AUCC at about that time to try to do the same thing for student aid.  I thought the idea was nuts – at the time, university Presidents primarily saw student aid as a revenue-generating device, and students weren’t going to sign up for that.

What bridged the gap was the decision to focus on student debt.  Students and Presidents might have different views about tuition, but everyone could agree that student debt was bad.  Heck, Paul Martin was on TV every damn night, telling us debt was bad.  Different kind of debt, obviously, but such was the zeitgeist – who could possibly be in favour of more debt?  And so we decided to focus on that.

As a matter of luck, in the summer of 1996, HRDC erroneously published an estimate stating that average debt among borrowers would reach $25,000 in 1998.  In fact, it would take another decade to do so, but the error allowed us to make invidious comparisons between student debt in Canada and debt among graduates of US private universities, where average debt at the time was about $17K.  Nothing spurred Chretien-era Liberals to action faster than invidious comparisons with the US;  All it took was one front page story in the Toronto Star, and suddenly student aid became a hot file.  A little help from our friends at CFS and other coalition allies, and all of a sudden, we had an entire federal budget dealing with student debt.

Bottom line: student debt didn’t organically become a political issue in Canada.  It was very much “invented” in Ottawa – a politically convenient way to paper-over the cracks of a lobbying coalition, and successfully cudgel against a sitting government at the same time.

October 28

Debt, Tuition, and Inequality

A few weeks ago, I noted on Twitter that back when I was in student politics (24 years and counting) we opposed tuition hikes because we feared their negative effect on access.  Back then, fees hadn’t increased in real terms in almost two decades, so there wasn’t much evidence either way on the issue.  More than two decades on, the evidence has accumulated, and, on the whole, it turns out that what we believed back then was mostly mistaken: despite much higher tuition, more students than ever are attending PSE, and more low-income students than ever are attending PSE.

As a result, it’s increasingly ridiculous to use access arguments against tuition increases: basically you’re reduced to slogans like, “tuition reduces access!  And it’s a disgrace more people are paying it every year!”  Given this, I asked Twitter peeps what the best grounds were for opposing higher tuition and debt.  The most common answer was some variation of “tuition/debt causes inequality”, on the grounds that graduates with debt accumulate assets more slowly than students without debt.

Superficially plausible, maybe, but still wrong.  Inequality doesn’t exist “because of” borrowing.  Everybody pays equal tuition fees; debt is incurred by those who don’t have the cash up front to pay for it.  Blaming student aid for inequality is just blaming student aid for the fact that some students come from poorer families, and others from richer ones.  You don’t have to condone inequality to realize that it’s a silly proposition.

So, students who go in rich don’t accumulate debt, and therefore end up richer at the other end; students who go in poor do accumulate debt, and therefore remain poorer at the other end.  But that would be true regardless of how fees are set.  If you reduce fees for all, everybody is made better by the same amount.  Poorer families end up with less debt, richer families get to keep more cash-in-hand.  For the abolition of fees to reduce inequality, it would have to create some kind of behavioural change among richer parents that would make them less likely to pass that extra money on to their kids.  And how likely is that?

These are all pretty basic observations, yet they rarely make it into the debate about tuition and debt.  Partly, it’s because inter-generational transfers complicate the analysis, but I think it’s mostly because debt makes people squirrelly.  As Margaret Atwood and David Graeber have pointed out in recent books, the concept of debt is tied-up with an enormous amount of cultural baggage, which makes it difficult to talk about in purely economic terms.  For the next couple of days, I’ll be unpacking some of these cultural issues, and how they affect our discourse on debt.

More tomorrow.

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