The economics of Hillary Clinton’s higher education plan

Hillary Clinton yesterday announced her “New College Compact,” the higher education plan central to her presidential campaign. While the plan is designed to address many issues associated with the cost and quality of higher education in the U.S. today, its policy proposals can be boiled down to the four primary themes identified below, which we discuss in terms of their likely economic impact.

Incentive-based subsidies

The Clinton plan promises to increase subsidies to higher education by creating a system in which states are eligible to receive federal grant money if they commit to providing students with affordable post-secondary opportunities. It vows to make enrollment at community colleges free and affordable without loans at four-year public institutions if students contribute the equivalent of wages from a 10 hour per-week job and families make the contribution prescribed by the aid eligibility formulas.

It isn’t clear from the plan how these affordability benchmarks will be measured exactly, but we can presume that institutions that meet these standards will be the beneficiaries of the federal funds. Of course, the concern with this portion of the plan is that it rewards affordability without an eye for quality. The easiest way for institutions to meet these, somewhat arbitrary standards of affordability, will be to cut corners when it comes to quality. However, another element of the Clinton plan related to institutional accountability (discussed below) may help mitigate this concern.      

While the plan calls for a dramatic increase in subsidies and promises “debt free tuition,” it falls short of promising debt free college, even at public institutions. The guidelines for affordability laid out in this plan demand that students and their families cover some of the expense of attendance out of current income or savings and do not cover expenses beyond tuition. Since tuition and fees account for only thirty percent of the overall cost of attendance (which includes tuition and fees and well as room and board) at two-year public colleges and 48 percent at four-year public colleges, this keeps students on the hook financially. Students may choose to use personal or family savings, earnings from a job, or loans to pay for non-tuition expenses.

Refinancing outstanding debt and reducing interest rates on new loans

This part of Clinton’s plan closely resembles legislation introduced by Senator Elizabeth Warren in 2014. Both Clinton and Warren’s proposals have intuitive appeal, given the frequent accounts we read in the media of individuals delaying major life milestones while struggling to repay huge student loan debts.

Clinton suggests that reducing interest rates on outstanding debts would help those borrowers and put money back into the pockets of the households that need it the most. Unfortunately, that’s not the case. As one of us has written in the past (with colleague Matthew Chingos), this plan is in fact largely regressive and not the least bit progressive:

Refinancing loans provides the greatest benefit to borrowers with large outstanding debts. This doesn’t seem like such a bad thing until you realize that households with large outstanding debts tend, on average, to be high-income households. Many borrowers who take on large debts do so in order to pursue degrees that lead to high incomes, in fields such as law and medicine. These are not the same households who are struggling financially and are perhaps in need of a bailout.

Our prior analysis indicates that higher-income households hold a disproportionate share of student loan debt. The richest 25 percent of families hold 40 percent of the student loans, and would therefore receive roughly 40 percent of the benefits of a proposal that allowed all loan debt to be refinanced at lower rates. On the other side of the income spectrum, the poorest quarter of households would receive less than one-fifth of the benefits of such a proposal. In another previous report, one of us showed that the borrowers with relative small loan balances are the ones who are struggling. These households would benefit the least from refinancing.

Lowering interest rates on new loans suffers from the same weakness; it distributes benefits to many borrowers who won’t need the help. We’d be better off spending those dollars elsewhere.

Make income-based repayment simple and universal

Despite concerns about the increasing cost of higher education, we know that for the typical student, an investment in a college degree has a large financial and social payoff, even taking into account the rising costs. This means that cost isn’t the problem, the problem is risk. When the cost of college was low relative to household income, students could afford to make a bad bet on college. They paid a price, but that price was low relative to annual and lifetime income. Now, students who make bad bets on college may find themselves in dire straits. This constitutes a fundamental change in the market for higher education and it demands a policy solution.

A streamlined income based repayment program, like the one in Clinton’s plan, is a step in the right direction. It helps to ensure that a student whose investment doesn’t pay off (for any reason) won’t face an unaffordable financial burden. Like the existing income based driven repayment plans, Clinton’s proposal would cap monthly payments at 10 percent of the borrower’s disposable income and forgive outstanding debt once a borrower has been making payments for 20 years. In addition, the plan proposes reforms that would make income based repayment easier to use. It replaces the complex set of programs with one single program, simplifies the enrollment process and proposes the option for borrowers to have payments withheld from their paychecks. These are important steps since we believe that the complexity of the current system may be limiting its effectiveness.

Mechanisms to address the increasing risk in the market for higher education are critically important and we believe that all candidates should incorporate some type of insurance mechanism for student borrowers in their platform on higher education reform. An effective social safety net can both ensure financial well-being of borrowers and ensure that future generations of students don’t shy away from enrolling in college out of fear of taking on debt.

Institutional accountability

Clinton proposes that institutions be held accountable for producing graduates who don’t succeed in repaying debt with two specific proposals. First, she calls for a revision of the current eligibility criteria for the federal aid system, a principle recently proposed in the bipartisan Student Protection and Success Act introduced by Senators Orrin Hatch and Jeanne Shaheen. The new criteria will hold institutions to a higher standard when it comes to measuring how many of their former students are successfully repaying their loans.

More notably, Clinton’s plan embraces the idea of institutional risk-sharing. Under a risk-sharing program, schools whose former students (graduates or non-completers) are failing to successfully repay their debts will have to pay a fee in the form of a contribution to a fund to support institutions that serve a high percentage of low- and moderate-income students, thus creating a financial incentive for institutions to help students succeed.

The advantage of risk-sharing is that it aligns incentives, making more salient the motivation for institutions to invest in student success. But there are two potential downsides of a risk-sharing plan. First, risk-sharing is likely to drive up costs. In order to produce better outcomes for students, institutions may wish to invest more in their students, which will ultimately be passed on to students in the form of higher costs. The second potential downside is that it works against ensuring access for disadvantaged populations. Instead of improving quality to ensure good student outcomes, institutions may also respond to this incentive by simply choosing to enroll students that have a high likelihood of success. At the same time, however, such actions on the part of colleges and universities might protect some students from taking on debt for schooling that isn’t likely to pay off. If an institution isn’t willing to take a risk on a students, that might be a good indicator that the student would be better off avoiding enrollment at that particular school. 

Conclusion

Ultimately, Clinton’s proposal addresses affordability concerns, demands accountability at the institution and state level, and shores up safety nets in an appropriate manner; unfortunately it also wastes money on solving a non-existent macro crisis in student lending rather than targeting relief to the borrowers who need it the most. Dropping the refinancing provision might make it possible for the plan to come in under the $350 billion price tag that other analysts have already begun criticizing as unrealistic.