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In response to Congressional requests to analyze
proposed federal programs that would provide income-contingent loans (ICLs)
to postsecondary students, this Congressional Budget Office (CBO) memorandum
examines the fundamental issues in designing such programs. It identifies
the key parameters that define an ICL program, discusses the relationships
among them, and explores other issues that bear on how an ICL program could
be fashioned. The analysis was performed by Jay Noell and Constance Rhind
of CBO's Health and Human Resources Division under the direction of Nancy
Gordon and Bruce Vavrichek. In accordance with CBO's mandate to provide
objective and impartial analysis, this memorandum contains no recommendations.
INTRODUCTION
BASIC PARAMETERS OF INCOME-CONTINGENT LOANS
WHO WOULD BE RESPONSIBLE FOR REPAYING AN ICL?
WOULD BORROWERS ALTER THEIR BEHAVIOR IN RESPONSE TO THE TERMS OF AN ICL?
WHAT OTHER FACTORS WOULD AFFECT THE TERMS OF AN ICL?
NEXT STEPS IN DESIGNING AN ICL PROGRAM
| TABLE | |
| 1. | Basic Types of Income-Contingent Loans |
| BOXES | |
| 1. | The Structure of an Income-Contingent Loan, Example 1: Income-Dependent Education Assistance Act of 1993 |
| 2. | The Structure of an Income-Contingent Loan, Example 2: Educational Opportunity Bank Income-Contingent Loan |
| 3. | The Structure of an Income-Contingent Loan, Example 3: Silber Income-Contingent Loan |
INTRODUCTION
Although economist Milton Friedman proposed using income-contingent loans to finance postsecondary education almost 40 years ago, many analysts continue to be concerned about the practicality of such loans.1 Being able to "borrow" from future earnings to finance a college education, which would in turn increase those earnings, has obvious appeal. But gaining popular support for a viable loan program in which repayment is linked to the borrower's future income has proved difficult. Such a loan program needs to have attractive terms for borrowers who require financial assistance to enroll in college, while avoiding negative and costly consequences for postsecondary institutions or for lenders, such as the federal government.
Several postsecondary schools have tried to run income-contingent loan (ICL) programs, but they have either discontinued them or restricted eligibility mostly to students choosing public-sector careers.2 In 1986, the federal government initiated a demonstration ICL program at 10 postsecondary institutions. The project was hampered from the beginning by various restrictions, however, and never achieved much support from students, the colleges, or policymakers. The 1992 amendments to the Higher Education Act terminated this project.
In the Omnibus Budget Reconciliation Act of 1993, however, the Congress instructed the Department of Education to create an income-contingent repayment option as part of a new direct student loan program.3 This option should allow students more flexibility in repaying their loans, even though many of the terms of the loans remain the same as in the guaranteed Federal Stafford Loan Program for students. Using an income-contingent repayment schedule, borrowers in the new program will have up to 25 years to repay their loans instead of the usual 10 years. In addition, the Congress said that any students who default on their federal direct student loans in the future can be required to repay their loans on the basis of an income-contingent repayment plan.
Many analysts believe that the income-contingent repayment option created by the Congress will be useful but that it does not address the broader possibilities inherent in income-contingent loans. In particular, ICLs could allow borrowers to receive much larger loans but tailor their repayments to their incomes. Today's guaranteed student loans typically require uniform repayments over a period of up to 10 years. These repayments can constitute a relatively large share of a borrower's income shortly after leaving school--when many of the borrowers who are going to default do so--although over time the relative burden of repayment generally declines as the borrower's income increases because of inflation and experience in the labor force.
As a preliminary effort to increase understanding of the larger role
that ICLs could play in financing postsecondary education, this memorandum
discusses some of the possibilities and constraints in designing a federal
income-contingent loan program. It lays out the four basic parameters necessary
to specify an income-contingent loan program. It then considers who should
be responsible for repaying these loans and whether the repayment terms
of an ICL would tend to change the behavior of borrowers. The memorandum
also explores several other essential considerations in setting the terms
of an ICL, such as the definition of income and the administrative burdens
entailed in delivering and servicing the loans.
1. Milton Friedman, "The Role of Government in Education," in Robert A. Solo, ed., Economics and the Public Interest (New Brunswick, N J.: Rutgers University Press, 1955).
2. D. Bruce Johnstone, New Patterns for College Lending: Income Contingent Loans (New York: Columbia University Press, 1972); and Robert D. Reischauer, "HELP: A Student Loan Program for the Twenty-First Century," in Lawrence E. Gladieux, ed., Radical Reform or Incremental Change: Student Loan Policy Alternatives for the Federal Government (New York: College Entrance Examination Board, 1989).
3. The Congress also required the Department of Education to develop an "income-sensitive" repayment option for its existing guaranteed student loans. In addition, the Congress has directed that a small number of borrowers who default on their guaranteed student loans be required to repay their loans according to an income-contingent repayment plan.
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