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September/October 2012 Answering the Critics of “Pay as You Earn” Plans

By Stephen Burd

Tying the repayment of student loans to a borrower’s income is hardly a new idea. Conservative economist Milton Friedman proposed the basic concept in 1955, and so-called income-contingent loans (ICLs), or “pay as you earn,” plans have been championed by many liberals since. This has also given critics plenty of time to come up with well-worn criticisms that are certain to come up again if this proposal gets legs. Here are some of the arguments, followed by our responses:

Instituting an income-contingent loan system and getting rid of collection agencies would give borrowers a free ride.

While such a system would provide much-needed relief to financially distressed borrowers, it would not absolve them of their responsibility to repay their debt. In fact, with the Internal Revenue Service automatically deducting payments from borrowers’ paychecks, it would become substantially more difficult for individuals to skip out on their loans. In other countries that use an ICL system, such as Australia and the United Kingdom, only a small minority of borrowers fail to meet their repayment obligations.

Since people with very low incomes don’t have to make any payments under this system, won’t it serve as a disincentive for borrowers to work and seek higher-paying jobs?

Just as people don’t generally choose a life of poverty to avoid paying taxes, it is highly unlikely that they would do so to escape their student loan debt. There isn’t any evidence from other countries using this system that these concerns are warranted. Also, society has an interest in making it financially easier for people to pursue callings such as primary medicine or public interest law that require advanced education but that pay only modestly or involve highly variable income, such as starting and running a small business.

The IRS won’t be able to handle the job of collecting on student loans. IRS officials have said in the past that the agency could handle the job.

At a House hearing in 1992 related to legislation that Wisconsin Representative Tom Petri sponsored to create an ICL program, Michael Bigelow, the agency’s then deputy assistant commissioner of returns processing, expressed concerns that the proposal could be practically difficult. Nevertheless, he noted that the agency already collected child support payments and delinquent small business loans successfully, and acknowledged that the IRS would “be able to collect student loan repayments, if that is the will of the Congress and the president.” And that was before all of the technological breakthroughs that have occurred over the past twenty years.

With the repayment relief this plan offers, colleges will no longer have any qualms about steering students to take on unmanageable levels of debt.

The government already puts limits on the amount of federal loan debt that borrowers can take out. These limits should remain in place under this plan. The potential for abuse could be further addressed by requiring colleges to have some skin in the game. For example, institutions should be put on the hook for a share of the losses that taxpayers sustain when a borrower defaults. Such a change would make schools think twice about overloading their students with excessive debt.

Such a change would make it easier for unscrupulous for-profit colleges to fleece their students.

It’s true that the Department of Education would no longer be able to judge schools by their default rates—since few students would default under such a system. However, with the IRS collecting income data and student debt levels of all borrowers, the government should easily be able to determine which schools are failing to provide gainful employment to their students, and remove them from the program. In addition, policymakers should, as they put ICL in place, redouble their efforts to strengthen the government’s gatekeeping system to prevent unscrupulous schools from getting access to federal student aid in the first place.

Further details about how such a system could be implemented in the United States have been put forth in a white paper by Erin Dillon, Affordable At Last: A New Student Loan System (Education Sector, 2011).

Stephen Burd is a senior policy analyst in the Education Policy Program at the New America Foundation.