News out of the U.S. suggests that one possible casualty of that country’s budget crisis is the in-school interest subsidy on student loans. Since Canadian governments almost always end up copying the Americans on student aid eventually (see: income-based grants, rules on institutional designation, workforce-related loan forgiveness, etc.), this seems like a good time for Canada to review its own policies on student loan interest.

Some countries, like Germany and many developing countries, charge no interest at all on student loans (Newfoundland and Labrador eliminated interest on provincial student loans in its 2009 budget). This is a wastefully expensive way to run a student loan system (effectively, once interest rates are considered, it is paying students to borrow) and does a poor job of targeting public money to those who need it most. Other countries, like Australia, charge students inflation but no real interest – this is somewhat less wasteful but still not brilliant. Countries such as the Netherlands are charging students a rate based on the cost of government borrowing – that is, they aren’t subsidizing loans, but they’re providing it to students at a rate substantially below par. Then there are countries which charge students something close to a market rate, and use the “profit” to cover losses from defaults.

The U.S. and Canada are the only countries that try to mix different approaches – unbelievably cheap loans (i.e., full interest subsidies) while students are in school, and market-like rates when borrowers are in repayment. From a policy perspective this makes almost no sense whatsoever as the biggest subsidies go to people who borrow a lot, but who repay quickly. In a system where 20% of borrowers repay within two years (largely thanks to hefty gifts from family members), it’s hard to say that this is an effective way to spend money.

For about what we’re paying now, we could move to a Dutch scheme where we charge students the government rate of borrowing throughout their loans. It would increase student debt at graduation, but also make that significantly easier to pay back. The big winners would be people with low post-graduate incomes that require many years to pay back their debts; the big losers would be people who get family members to pay off their debts after graduation.

Which group would you rather got our tax dollars?