Protect Students as We Protect Businesses

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A post-secondary degree has become increasingly essential for success in the current economy. However, given that financial aid has not kept pace (pdf) with the skyrocketing costs (pdf) of higher education, getting that college degree has become much more challenging. The government has a clear role to play in making higher education accessible for all qualified students. In addition to providing the funds, the government can also help students manage (and insure against) the risks presented by post-secondary school.
 
It is useful to think of the decision to pursue higher education as an investment on the part of the student in their own human capital. When a private business chooses to invest in their physical capital, they can borrow against the expected gains from that investment--say a new machine, for example. However, a student cannot borrow against their expected future earnings. This is a major reason (pdf) why the federal government has taken such an active role in both directly offering loans itself and subsidizing student loans from private lenders. Indeed, the federal government provides an explicit guarantee that it will protect private lenders in case a student defaults on their loan. But why insure the private lender against this risk? Why not give the protection directly to the student?
 
This is essentially what the Income-Based Repayment system that the federal government instituted in 2007 changes. The new policy helps protect students against the possibility that they will not be in a position to pay back their federal loan. Monthly loan payments are tied to a student’s earnings after graduation. If their income falls below a certain level, these payments can be temporarily waived. Loans are forgiven after 25 years of qualifying payment. This system ought to be strengthened and expanded to more students (as President Obama has proposed). It should also be simplified.
 
But there is another important risk that the government is not currently insuring students against: the risk that students will not finish their degree and still be saddled with debt. About half of all Americans with student debt have dropped out of school. Most students who drop out cite economic reasons, according to a recent survey by the Gates Foundation. These students generally either cannot afford to continue classes or cannot balance employment and their coursework. 
 
Another comparison with private businesses is useful here. The tax code allows individuals and businesses to deduct the losses associated with a failed investment from their income taxes, with the goal of promoting investment in financial capital. Students, too, should be shielded, in part, from the “downside” risk of not completing higher education to encourage continued investment in human capital. By forgiving only a portion of their loan, students will still have a strong financial incentive to complete their degree.
 
Several economists have recently proposed the idea of “college failure insurance” that would pay a portion of a student’s loan in the event that he or she does not successfully complete a degree. The specifics of such a policy must be carefully established to ensure that students who would need the insurance the most could afford to participate. And the government should encourage high school students to invest in their own education by giving them the same protections that private investors and companies receive.
 
If you found this piece informative, read this post on the affordability of student internships.
 
(Photo from Wikimedia by "punctured bicycle")