An Analysis of the College Cost Reduction Act

Key points

• The College Cost Reduction Act would hold colleges and universities financially responsible for unpaid federal student loans while delivering direct aid to institutions with low prices and strong student outcomes.
• The proposal would save taxpayers $1.8 billion per year overall and would redistribute federal resources between institutions according to cost and performance.
• Public community colleges, which have large low-income student populations and charge relatively low tuition, would receive a net $1.6 billion per year under the proposal.
• Private four-year universities, especially those that charge excessive tuition and rely on low-quality graduate degree programs for revenue, would face the largest net liabilities.

Introduction

Last month, House Republicans led by Representative Virginia Foxx (R., N.C.) introduced a comprehensive overhaul of the Higher Education Act, the main law governing federal involvement in postsecondary education. The bill, known as the College Cost Reduction Act, tackles the high costs and subpar outcomes that plague many sectors of American higher education.

FREOPP has documented these problems through our analysis of return on investment (ROI) in higher education. Our research has shown that 28 percent of bachelor’s degrees and 41 percent of master’s degrees do not increase students’ earnings enough to justify their costs. Yet these degree programs enjoy unfettered access to federal grant and loan funding, often charging students tens of thousands of dollars for credentials that may not deliver the economic mobility most students seek. The student loan crisis is downstream of this phenomenon, as the federal government allows borrowers to take on too much debt for too little return.

For too long, federal higher education policy has operated under the unspoken assumption that college always pays off, and therefore there is little need for guardrails or accountability. That modus operandi is no longer defensible.

The College Cost Reduction Act’s centerpiece is a requirement that colleges reimburse taxpayers for losses on their students’ federal loans. Colleges which load their students up with too much debt relative to earnings after graduation will face larger liabilities, but they can reduce these costs by lowering their prices or improving the quality of their education to boost graduates’ earnings. Moreover, colleges with low tuition and solid student outcomes will be eligible for new direct payments from the federal government, known as PROMISE Grants.

Several other provisions of the College Cost Reduction Act support the goal of aligning colleges’ incentives with student outcomes. The proposal limits the amount of federal loans that colleges can foist upon students and creates a new loan repayment plan that would ensure most borrowers pay down principal on their debts. At several points, institutions are rewarded for reducing tuition and guaranteeing a set price to students for their entire college experience.

This issue brief analyzes two central pillars of the College Cost Reduction Act: the “risk-sharing” requirement for colleges to assist with student loan repayment and the performance bonus for schools with low prices and strong outcomes. It does not directly measure the impacts of the other provisions of the bill, other than to analyze how those policies may interact with the risk-sharing and performance bonus provisions.

Key provisions of the House proposal

The College Cost Reduction Act is far-reaching. I focus here on the provisions that directly affect tuition and federal financial aid.

• Loan repayment assistance: The bill pares down the confusing array of federal student loan repayment plans to two: a standard “mortgage-style” plan and an income-driven repayment plan. Borrowers choosing the income-driven plan must pay ten percent of their annual income above a set threshold (currently $21,870). However, borrowers who make positive payments will see at least half their payment applied to loan principal, even if the payment does not fully cover accrued interest. Any remaining unpaid interest is forgiven.
• Student loan risk-sharing: Colleges, rather than students, are responsible for the costs of repayment assistance. Schools will be required to compensate the government for a portion of the forgiven unpaid interest associated with their former students. Colleges are also responsible for missed payments when students choose the standard mortgage-style plan. Colleges may waive half their risk-sharing liabilities if they agree to close the program that triggered those liabilities.
• Performance bonus: Schools may be eligible for new direct payments from the federal government, known as PROMISE Grants. These payments are determined by a formula that rewards colleges for low-income student enrollment, high graduation rates, low tuition prices, and strong graduate earnings outcomes.
• Campus-based aid: Existing campus-based aid funds under the Federal Supplemental Educational Opportunity Grant (FSEOG) and Federal Work-Study (FWS) programs are deducted from each school’s PROMISE Grant. However, if a school’s PROMISE Grant exceeds its campus-based aid allocation, it may use campus-based aid funds for any purpose, not just the purpose for which the funds were given.
• Loan limits: The bill caps aggregate student loan limits at $50,000 for undergraduate students, $100,000 for graduate students, and $150,000 for students in graduate professional programs. The bill also pares back annual loan limits for schools with excessively high tuition. The Grad PLUS and Parent PLUS loan programs, which currently allow borrowers to take on effectively unlimited amounts of debt, are eliminated.
• Maximum price guarantee: In order to be eligible for PROMISE Grants, colleges must guarantee that the net tuition that students pay in their first year will not increase in subsequent years, for as long as the student is enrolled at the institution (up to a maximum of six years or the institution’s median time to completion, whichever is less). In addition, annual federal aid per student (Pell Grants and loans combined) is capped at the national median cost of attendance for similar programs.

Risk-sharing and performance bonus details

Each college’s risk-sharing liability and performance bonus is determined by a complex formula, which aims to reward schools for increasing graduates’ earnings and keeping tuition low.

First, the bill instructs the Department of Education (ED) to calculate an earnings-price ratio (EPR) for each individual degree or certificate program at federally funded institutions. The EPR is equal to the median earnings of former students shortly after graduation minus 150 percent of the federal poverty line (300 percent for graduate programs), divided by the total price that students paid while enrolled (after accounting for scholarship aid provided by the institution and state governments, but before federal Pell Grants).

For instance, graduates of the psychology program at the University of Southern California earn a median salary of $49,000 shortly after graduation, while their total tuition liability for four years is $156,000. The EPR for this program is equal to $49,000 minus 150 percent of the federal poverty line, divided by $156,000; the quotient is a value of 0.18.

After students graduate or withdraw from the institution, ED measures the degree to which the cohort either fails to pay back their loans or requires repayment assistance through the income-driven repayment plan. Each year, ED totals up the balance of the loans that are in nonpayment and multiplies that amount by one minus the program’s EPR. The institution must then pay ED this amount to partially compensate taxpayers for the losses on those loans.

For example, a program with an EPR of 0.18 triggers a liability equal to 82 percent of balances in nonpayment. Schools can therefore reduce their potential risk-sharing liabilities by reducing tuition, which will raise their EPR. Schools with high EPRs may also be eligible for a PROMISE Grant.

To calculate the PROMISE Grant for each institution, ED first calculates the total amount of Pell Grant aid awarded to the institution each year. Pell Grants are means-tested, meaning lower-income students receive larger grants. ED multiplies total Pell aid by the institution’s overall EPR (minus one). Finally, ED multiplies this product by the proportion of students at the institution who complete their programs on time.

The product of these three factors — total Pell aid, average EPR minus one, and on-time completion rate — is equal to the gross PROMISE Grant that ED will pay to the institution directly each year. Consider the example of the State Technical College of Missouri. This community college’s students receive $2.7 million in Pell Grant aid every year. The school’s on-time completion rate is 71 percent, and its average EPR is 3. Its gross PROMISE Grant is equal to $2.7 million times 71 percent times 2 (3 minus 1), or $3.8 million. The $85,000 in campus-based aid that the school already receives every year is then deducted from this total, so the school’s net PROMISE Grant is $3.7 million.

Using existing data from the College Scorecard on debt, graduate earnings, and tuition prices at thousands of colleges nationwide, I estimate the risk-sharing liabilities and performance bonuses that each school could be liable or eligible for were the College Cost Reduction Act to become law. At some schools, liabilities will exceed bonuses, while at others bonuses will exceed liabilities. Some schools will see a net financial gain, while others will see a loss.

I do not model the effect that other provisions of the law, such as the elimination of Grad PLUS and Parent PLUS, might have on university finances, but I do assume that these other provisions are extant as I model the risk-sharing penalties and performance bonuses.

Results

There is sufficient data to estimate both a risk-sharing payment and a PROMISE Grant (even if zero) for 4,078 institutions representing 15.4 million of America’s 16.7 million full-time equivalent (FTE) postsecondary students.

I calculate the net present value of risk-sharing penalties associated with loans belonging to students who separate from higher education in a given academic year. From the roughly 4,000 institutions with sufficient data to estimate risk sharing penalties, I estimate that the federal government will collect $6.7 billion on each annual cohort of loans.

By contrast, the government will pay out $4.8 billion per year in net Promise Grants to the 4,078 institutions with sufficient data to make such an estimate. Taxpayers will therefore save an estimated $1.8 billion per year from these provisions of the bill.

These figures assume that the other provisions of the College Cost Reduction Act, including the changes to income-driven repayment and new loan limits, are enacted at the same time as the risk-sharing and performance bonus provisions. However, this analysis does not directly model the budgetary impacts of those other provisions, though it is likely they will save taxpayers money on net.

The estimates also do not incorporate the dynamic effects of the risk-sharing and performance bonuses; for instance, institutions may try to increase their PROMISE Grants by cutting tuition or raising completion rates. Such dynamic effects may reduce the government’s net savings, but they will help achieve the legislation’s policy goals of lower prices and better student outcomes.

While the federal government will collect more in risk-sharing penalties than it pays out in performance bonuses, the net impact on university budgets is not constant across various sectors of higher education.

Public community colleges, which primarily grant credentials of two years or less, are the biggest “net winners” under the House plan. This sector stands to collect a net $1.6 billion in bonuses after subtracting risk-sharing liabilities and repurposed campus-based aid. The low prices and short durations of these programs mean public community colleges reap the biggest rewards of the House plan’s emphasis on low tuition. The size of community colleges’ performance bonuses, however, is currently limited by the sector’s low on-time completion rates.

The biggest “net losers,” by contrast, are four-year private nonprofit colleges and universities, which face an estimated $3.2 billion in risk-sharing liabilities. A major reason for the sector’s heavy liabilities is its extreme reliance on graduate programs and their associated federal loans. Since graduate debt burdens are far larger on a per-student basis than undergraduate burdens, schools with large graduate programs are exposed to significantly higher risk-sharing liabilities, especially if students earn too little relative to their debts. Graduate programs also do not contribute to a school’s PROMISE Grant, which is based on undergraduate-only Pell Grant awards.

Among individual schools, the biggest net winner is the University of Central Florida (UCF), one of the largest public schools in the nation. UCF will receive $139 million per year in net payments from the government. Public universities in states with low tuition and lower-income student bodies tend to perform well, especially the California State University system. Large community colleges such as Miami Dade College and Dallas College can also expect to enjoy substantial PROMISE Grants.

A few private schools net large bonuses. Utah’s Western Governors University, an online nonprofit offering competency-based education, stands to collect $90 million per year under the House plan. The school’s large low-income student population, relatively high completion rate and affordable tuition are all factors in its handsome performance bonus.

By contrast, expensive private schools with large graduate student populations dominate the list of the largest net losers under the House plan. One school infamous for its high tuition — the University of Southern California — would face more than $166 million in net risk-sharing liabilities.

Other large private nonprofit schools, many with elite reputations, would trigger substantial net penalties. These include New York University, Columbia University, Northwestern University, and Boston University. The net losers list also includes several major for-profit colleges and large less-selective nonprofits, along with some detached graduate schools that leave their students with very heavy debt burdens.

These figures look more manageable on a per-student basis. Across all institutions, the median net penalty is just $51 per full-time equivalent (FTE) student. Most institutions charged a net penalty will pay less than $300 per student. However, some schools face significantly larger penalties. The average four-year proprietary school will pay nearly $1,400 per FTE student.

Additionally, most schools with net bonuses will receive less than $500 per FTE student. Some schools, however, will enjoy significantly larger net bonuses, especially public community colleges with a strong vocational bent such as the Tennessee College of Applied Technology and Northwest Louisiana Technical Community College.

Finally, I investigate whether the penalty-and-bonus system in the House plan effectively targets institutions which are leaving students worse off financially. FREOPP has estimated return on investment (ROI) for tens of thousands of degree and certificate programs, defined as the increase in earnings attributable to the credential minus college costs. I calculate each institution’s average ROI and compare that figure to the net penalty or bonus the institution receives under the House plan.

The proposal does a good job of penalizing institutions where the average student is worse off for having enrolled. Around 85 percent of institutions where average ROI is negative would face a net penalty, and nearly half would face a penalty exceeding $500 per FTE student.

However, the penalties in the College Cost Reduction Act are stringent, even for schools providing positive ROI. Around half of schools where the typical student is better off for having enrolled nonetheless face a net risk-sharing penalty, though this liability is generally less than $500 per student.

In fact, the schools least likely to face a penalty — and most likely to receive a bonus — are those where average lifetime ROI is modest, but still positive. One reason is that these schools enroll more low-income students who qualify for Pell Grants, boosting the size of their PROMISE Grants. The highest-ROI schools tend to enroll fewer low-income students, so they qualify for only small PROMISE Grants, which do not outweigh the penalties they face on their low-return programs. Among schools where average ROI is positive, 59 percent of those serving mostly low-income students enjoy a net bonus, compared to just 33 percent of those serving mostly high-income students.

Conclusion

The risk-sharing and performance bonus provisions of the College Cost Reduction Act will likely save taxpayers $1.8 billion per year by redistributing federal resources between institutions. Schools with low tuition and large low-income student populations will enjoy substantial performance bonuses, while those that charge excessive tuition for degrees that do not justify their costs could face large liabilities.

If the College Cost Reduction Act becomes law, however, its most important impact could be its effect on incentives. Institutions will face smaller penalties and enjoy larger bonuses if they take steps to serve students better: namely, lowering tuition levels and student debt, raising completion rates, enrolling more low-income students, and improving the economic outcomes of their degree programs. While those dynamic effects are not modeled in this analysis, they may represent the bill’s most meaningful long-term result.

Update (2/7/24): This report has been updated to reflect an amendment to the College Cost Reduction Act agreed to during the January 31 full committee markup of the bill. These changes include eliminating the “Pell Plus” program and preserving FSEOG, as well as subtracting FSEOG and FWS funds from each institution’s PROMISE Grant.