IBR

LawProf and commenters have noted many downsides of the Income Based Repayment (IBR) program for educational loans. IBR is the only way for many graduates to meet their loan repayments, but the program greatly increases total interest, hampers attempts to secure a mortgage, and burdens graduates for as long as 25 years. (A shorter, 20-year version of IBR may be available soon, but some older loans won't qualify for that reduced term.) Graduates who do not work in public service will also owe income tax on any debt forgiven at the end of the IBR period.

From a public policy perspective, IBR raises other troubling issues. Taxpayers foot the bill for forgiven debt, and those sums may exceed original forecasts. The program further distorts the market for higher education, giving schools the freedom to raise tuition still higher while students take on still more debt.

But there are two other problems with IBR that have received less discussion. The first is a moral issue: IBR has helped change education from an investment that we all make in the future to one that new adults (our future) have to make in themselves. IBR, like several other government programs, represents an enormous shift in economic resources from new workers to middle aged and older ones.

I'm not talking just about the loss in tax money to support higher education. Those losses have hurt, and they have required students to invest more in their own education, but the decline in tax support hasn't fueled the full rise in tuition or student debt. Public law schools are fond of saying things like "state support now accounts for only 25% of our budget, while it used to provide 70%." Those statements are like ones that politicians make: They distort reality by omitting key facts.

Here's a hypothetical to explain the more complicated relationship among tuition, state support, and school budgets: Suppose that a small public law school was operating on $10 million per year in 2000, with $7 million coming from state support. The taxpayers, therefore, paid 70% of the school's budget. Inflation then pushed the school's overall budget to $13.4 million in 2012. Keeping pace with inflation would have required state support to increase to about $9.4 million, but the state increased its support only to $7.5 million. In inflation-adjusted dollars, that's a loss of about 20% in state funding  --a serious concern to the school, but not nearly the drop that "70% to 25%" suggests.

What accounts for the much greater drop in state support as a percentage of the budget? Like most schools, both public and private, this representative school increased its overall budget. Suppose this school hired more faculty and staff, raised faculty salaries, lowered teaching loads, awarded more merit-based scholarships, and did all of the other costly things that schools have done during the last twenty years. As a result, the overall 2012 budget reached $30 million. State funds weren't available for the school's enhancements, so the school engaged in aggressive fund raising (something few public law schools did thirty years ago) and tuition increases. As a result, the school's 2012 budget might be $30 million, and state support might account for only 25% of that budget, but most of the "loss" in state support really stems from the massive new expenditures that the state declined to support.

This brings us back to IBR. Both public and private institutions spend much more today to fulfill the basic functions (teaching, research, and service) that they performed twenty years ago. Some of that money has come from alumni giving back to the institutions they attended. These alumni recognize that the school, previous graduates, and society at large invested in them; they have been willing to "pay that debt forward" by making charitable gifts to their alma maters.

But much of that new money has come from tuition. That's where government-backed loans and IBR come in. Government loans have greatly facilitated the rise in tuition, together with the accompanying expansion of loans for living expenses. Without those loans, many fewer students could have paid our tuition or taken the opportunity to stay out of the full-time workforce for 4-7 years.

Think for a moment where that loan money goes. A lot goes into the pockets of professors and deans; their money flows out again to pay for daycare (if the profs are young) and vacation homes (if the profs are older). That money also buys theater tickets, books, ipads, restaurant meals, and all of the other things that professors like to buy. Another portion of student loan money pays the salaries for new staff at universities. Still other parts of the student loan dollar go to campus bars, pizza delivery services, apartment landlords, textbook sellers, and everyone else who sells to students.

Higher education, in other words, stimulates a lot of economic activity--and that's a good thing. But here's the moral point: We're paying for much of that activity out of the future income of students, not out of current resources. Today's pizza shops, textbook publishers, and professors are all very happy, but they're not being paid by today's economic resources; they're living off students' future income. We're using the future to finance the present, and we're concentrating those future costs on the youngest members of the workforce--those who benefited least from the economic growth of the last sixty years.

This transfer, by the way, occurs within the tax system as well. The pizza sellers, textbook publishers, and professors pay more income and payroll taxes on their higher earnings, but that money doesn't go toward reducing the loan burden on students. Most of the payroll taxes go toward Social Security and Medicare, which benefit older citizens. And the general tax revenues support everything else government does, programs that may benefit students (everyone likes a good highway), but give those younger citizens no special benefit.

IBR extends the life of this intergenerational transfer. An increasing number of students can't pay back, under their original loan terms, the high tuition and other payments we extracted from them. Rather than recognize that the cost was too high--that we paid for current economic activity with the future income of students--we are extending the terms of repayment. That does nothing to ease the moral unfairness of building prosperity for established workers on the future income of new workers. IBR has obscured that unpleasant reality, not only by postponing the day of economic reckoning but by promoting rhetoric that graduates should be responsible, that they have invested in their futures, and that they will benefit eventually from that investment.

Graduates, of course, should be responsible; most of them are. It's also true that they have invested in their futures, which is admirable. And it's likely that some graduates will benefit eventually from their investment--although we know with near certainty that others won't. But those facts don't matter; they were also true for previous generations. The key moral facts are that: (a) universities asked prior generations of students to invest far less of their future income in their education; (b) the economic future for today's graduates is far more uncertain than the future was for last generation's graduates, not only because of changes in the legal market, but because of broader economic weaknesses (for just one example, think Medicare); and (c) we have been funding current prosperity--all of that economic activity you see on and around campuses--with the future income of new workers. That's not fair.

As I'll show in my next post, this is also economically foolish. Student loans and IBR are digging a trench under the U.S. economy. This isn't a bubble like the housing one; it won't burst suddenly. Instead, student loans and IBR are digging a long, horizontal ditch under the future economy; they will depress spending by a key portion of our future wage earners. Stay tuned for IBR: point two.