Aligning Higher Education’s Cost to its Value
A three-part proposal to hold colleges accountable for degrees that cost too much and deliver too little.
Executive Summary
- Millions of student borrowers are not paying down their loans. The primary cause is education that costs too much and delivers too little.
- The accountability system in our proposal requires colleges to compensate taxpayers when student loans go unpaid, thus discouraging low-value degrees.
- Proceeds from our proposed risk-sharing system are reinvested into financial aid for low- and middle-income students who enroll in low-cost, high-value programs.
- We estimate that our proposal will save $6 billion annually and protect students from educational programs without a positive return on investment.
- We have developed model federal legislation that reflects these concepts. For more details on the proposal, visit the policy appendix.
The federal student loan program is broken. Before the moratorium on loan payments, 11 million borrowers were delinquent or in default on their debts. Taxpayers have suffered enormous losses on federal loans and will suffer even more if the Biden administration successfully slashes monthly payments and cancels hundreds of billions of dollars outright.
The root of the problem is not an insufficient subsidy. Rather, too often the amounts that students pay for higher education are out of line with the economic value colleges deliver. Many degrees do not increase students’ earnings enough to justify the costs of college, and many students don’t finish their degrees at all. Students and taxpayers invest billions of dollars in higher education every year, but it often doesn’t pay off. When borrowers cannot repay their loans, this misalignment of cost and value is the underlying cause.
We propose a new system of accountability for higher education to ensure that colleges receiving taxpayer dollars provide value for money, and don’t leave students unable to repay their debts. Specifically, it requires colleges to compensate taxpayers for unpaid student loans, and reinvests the savings into grant aid for low- and middle-income students in high-value programs.
The bedrock of this proposal is a requirement that colleges share the risk of student loan nonpayment. Under this proposal, the government would assess whether borrowers have made satisfactory progress on their debts five years after they entered repayment. If not, their colleges must compensate the government for some or all of the loans that remain unpaid.
We propose a new system of accountability for higher education to ensure that colleges receiving taxpayer dollars provide value for money, and don’t leave students unable to repay their debts.
This compensation requirement is moderate if borrowers are only slightly behind on their payments. The financial liability will be a nudge for institutions to improve their programs by lowering prices or providing more career-relevant curricula. But as repayment rates fall, colleges’ financial responsibility increases. For the worst programs, the compensation requirement will be severe enough that schools will find it advantageous to withdraw those programs from federal loans entirely.
To safeguard taxpayers’ investment and ensure that schools have immediate skin in the game, the U.S. Department of Education (Education Department or ED) holds back a portion of loan disbursements from schools until it determines that students are making satisfactory progress on their loans. Schools will not receive their federal funding in full until they can guarantee the outcomes that taxpayers expect for their investment in higher education.
These changes will reduce government losses on student loans. The plan reinvests most of the savings into financial aid for low- and middle-income students. However, that new aid is conditional on enrolling in a program that delivers strong economic outcomes for a reasonable price. This will encourage schools with low tuition to enroll more disadvantaged students in their highest-value programs.
An accountability system to align cost and value in higher education is long overdue. Annually, the proposal in this white paper will return $7.5 billion to low-income students through enhanced financial aid and save taxpayers an additional $6 billion. Low-quality higher education programs will withdraw from federal loans, meaning fewer borrowers will end up with debt they cannot repay.
This white paper is accompanied by model legislation, the Higher Education Accountability for Loans (HEAL) Act, to enact the accountability system described.
For too long, the federal student loan program has been a drag on the federal budget that fails to reliably help students leverage higher education to increase their earnings potential. The accountability system laid out in this white paper can change that.
Introduction
For decades, a college education has been viewed as a golden ticket to the middle class: people with a college degree earn significantly more over their lifetimes than people without. While that remains true on average, not all forms of postsecondary education deliver an increase in lifetime earnings large enough to justify college costs. Many students graduate with degrees with little labor market value, while others take on debt to pursue a degree but fail to complete it.
The increasing prevalence of investments in higher education that do not pay off financially led to widespread anger at the instrument that financed most of those investments: the federal student loan program. The federal government disbursed $1.3 trillion in student loans between 2010 and 2022, accounting for 90 percent of all education lending. Many of those loans went bad: prior to the COVID-19 pandemic, 11 million borrowers were delinquent or in default on their loans.
Policymakers responded to borrower anger by offering ever-more-generous repayment plans, universal forbearance, and eventually outright cancellation, shifting the burden of educational malinvestment from students to taxpayers. This eased some of the financial pressure on borrowers, but dramatically increased the fiscal cost of operating the loan program.
But larger subsidies do not solve the underlying problem. Through no-strings-attached student aid programs, the federal government has given both approval and funding to educational options with a questionable or nonexistent payoff. Students in these low-return programs suffer both the direct costs of tuition and loan payments and the indirect costs of time out of the labor force and other lost opportunities. Many end up in a worse financial position than they started.
Through no-strings-attached student aid programs, the federal government has given both approval and funding to educational options with a questionable or nonexistent payoff.
This white paper proposes an accountability system to align the cost of the degrees and certificates that the federal government funds with the earnings those credentials deliver. The proposal aims to assure students that their investments in postsecondary education will yield a positive return.
Until now, the government has addressed the misalignment between cost and value on the back end, pouring taxpayer dollars into the student loan program to make debt more bearable. This proposal will address the problem on the front end. By steering new federal funding towards high-return programs, student borrowers will be in a stronger position to repay their loans, and there will be less political pressure for bailouts.
Attaching conditions to federal aid might smack of central planning, but the proposal does not accomplish its goals by picking winners and losers. Instead, the proposal creates financial incentives for colleges and universities to expand high-value programs, improve low-value programs, and eliminate programs with no value. The responsibility for identifying a program’s value rests with colleges, not the government, which cannot foresee which programs will be valuable or not. Aligning financial incentives between students, institutions, and taxpayers will allow market forces to ensure that American higher education produces enough value to justify its cost.
A three-part system for effective accountability
The accountability system consists of three components. First, it requires schools to compensate the government for a portion of the federal loans that their former students fail to repay. There is a strong correlation between loan repayment outcomes and return on investment; students struggle to repay their debts when they enroll in programs in which costs are out of line with earnings. Institutions must either lower their costs or improve their outcomes to avoid financial penalties if they are required to share in the risk of student loan nonpayment. This “risk-sharing” system creates a direct incentive to invest in high-value programs.
Second, the proposal requires schools to supply a financial guarantee to safeguard taxpayers’ investment. Loan repayment rates are realized several years after loans are disbursed, meaning risk-sharing is applied with a severe lag. To ensure that colleges and universities face an immediate financial incentive to improve their outcomes, the federal government holds back a portion of schools’ loan funding until they guarantee they can produce the results taxpayers expect.
Third, the system reinvests revenues from student loan risk-sharing into financial aid for low- and middle-income students — but only for programs with a high return on investment. The proposal boosts the maximum Pell Grant by up to $5,000 for programs where graduates’ earnings are high relative to the price they paid. This will encourage students to choose high-value fields of study and provide institutions with extra fiscal breathing room to expand programs serving low-income students well.
Much of the value of a college education depends on the field of study, so most individual institutions have a mix of high- and low-value programs. The accountability framework rewards colleges that expand their high-value offerings and improve or downsize their low-value ones. Few colleges will need to close, but most will need to adapt.
Students will benefit the most from this alignment of cost and value. Society will benefit from a labor force with skills that align with the needs of the modern economy. The proposal will also save taxpayers $6 billion per year, even accounting for the new Pell Grant bonus, as the government collects compensation from colleges and originates fewer loans that wind up going bad. This will reduce the deficit and ease inflationary pressures.
The status quo in federal student lending is unsustainable: even if President Biden’s $430 billion student loan cancellation survives legal challenges, independent analysts figure that outstanding debt will climb back up to pre-cancellation levels by 2028. Unless something is done to hold schools accountable for their outcomes and curb new loans that are likely to go bad, the cycle of more debt and more political pressure for forgiveness will continue. The accountability system in this white paper offers a way forward.
Background
The federal government supplies colleges and universities with funding through federal student aid programs to the tune of $142 billion per year. The two most significant components of federal aid are student loans ($89 billion annually), which are repayable and available to all students, and Pell Grants ($28 billion), which are not repayable and means-tested.
Why student loans go bad
The loan program is by far the most fraught component of student aid. Student loan interest rates are set above rates on U.S. Treasury bonds, meaning the loans would turn a profit for taxpayers if all borrowers repaid in full. But in practice, many of these loans have gone bad. Lifetime default rates on undergraduate debt have exceeded 25 percent, according to Brookings Institution estimates. Students who do not default can take advantage of repayment plans that link loan payments to income and forgive unpaid debt, meaning borrowers in programs that deliver low earnings often do not repay their debts in full.
In May 2022, the Congressional Budget Office estimated (using fair-value accounting) that taxpayers would lose 10 cents for every dollar in student loans issued that year. Those estimates do not include two actions that the Biden administration announced in August: the cancellation of up to $20,000 in student debt per borrower and dramatically reduced payments on income-based repayment plans. These actions will significantly increase the subsidy rate on federal loans, and the subsidies will be more significant for loans used to finance low-return programs.
That the Biden administration viewed loan cancellation and payment reductions as necessary changes to make loans affordable for borrowers demonstrates implicit skepticism about the value of higher education. If college provides a positive financial return, debt cancellation shouldn’t be necessary. If cancellation is needed, then federal loans finance degrees that do not justify their cost.
If college provides a positive financial return to students, it wouldn’t be necessary to cancel their loans. Cancellation indicates that federal loans are propping up degrees that do not justify their cost.
We have produced estimates of the return on investment (ROI) for tens of thousands of higher education programs. ROI compares the boost in lifetime earnings resulting from a degree or certificate to that credential’s costs. The estimates reveal considerable variation in higher education’s financial returns. Some programs increase their students’ lifetime earnings by millions of dollars, while others leave students financially worse off than they would have been otherwise.
If a program provides stronger ROI, its students are far more likely to pay down their loans because their payments will be more manageable when earnings are higher and costs are lower. Conditional on credential type, ROI explains roughly half the variation in student loan repayment rates. Even among students attending the same college, those choosing more remunerative majors pay down their loans faster.
To fix the student loan program’s problems, policymakers must ensure that federal loan dollars flow only to programs that provide students with decent ROI. Unfortunately, existing measures to hold colleges and universities accountable for student outcomes fall well short of what is needed.
Why the current accountability system is inadequate
The main entities responsible for quality control among colleges and universities participating in federal student aid are accreditors. Using their own criteria, these private nonprofit agencies determine whether institutions or programs should be eligible to access federal grants and loans.
However, accreditors rarely enforce student outcomes standards at colleges: one study found that less than three percent of accreditor actions against colleges had anything to do with student outcomes or academic quality. Moreover, most accreditation commissions are stacked with representatives of the same colleges they oversee, creating conflicts of interest. As a result, accreditation largely fails as an avenue for outcomes-based accountability.
Apart from accreditation, the Education Department enforces an outcomes-based accountability measure in the federal student loan program. The cohort default rate (CDR) is the percentage of borrowers who go 360 days without making a payment on their loans. When a school’s CDR surpasses 30 percent for three years in a row or 40 percent for one year, the school should lose access to federal student loans. But the high default rate threshold combined with a stark vulnerability to manipulation means that even institutions of the lowest quality rarely lose access to aid in the real world.
The Biden administration has proposed another outcomes-based accountability system to supplement CDR, known as Gainful Employment (GE). While not yet finalized, a draft GE framework released in March 2022 would terminate a higher education program’s eligibility for federal aid if its graduates’ earnings are too low relative to their debt levels. GE is an improvement over CDR, but a FREOPP analysis shows that GE exempts most negative-ROI programs from sanctions, especially at the graduate level. Moreover, GE utilizes an “all-or-nothing” enforcement mechanism: programs with outcomes below some arbitrary threshold completely lose access to aid, while those just above are entirely in the clear. This framework fails to encourage continuous improvement.
Building a more comprehensive accountability system
A three-part system is necessary for an effective accountability regime. The first component is a risk-sharing system that requires colleges to compensate taxpayers when their former students cannot repay their loans. If borrowers’ incomes are too low to pay down their debts, then borrowers hold the debt for longer and taxpayers pick up the tab for unpaid balances. More importantly, loan nonrepayment is a signal that the program those loans financed failed to deliver a positive return on investment.
A risk-sharing framework will address these problems. The accountability plan requires institutions to compensate the federal government for a portion of unpaid student loans. These compensation requirements will be progressive. Colleges with graduates mostly on track to repay their loans may not need to compensate taxpayers at all. But programs with lower repayment rates must pay much more compensation, up to the total amount of the loan. Ensuring that colleges are financially responsible for loan outcomes, at least in part, creates a powerful incentive to improve these outcomes by lowering tuition, increasing graduate earnings, closing nonperforming programs, and shifting enrollment to high-value fields of study.
The central challenge in outcomes-based accountability is a significant lag between when the federal government disburses student aid and when it measures student outcomes. If risk-sharing liabilities are far off in the future, the institution has a weaker incentive to change its behavior today. A college president may not make the difficult choices needed to improve her institution if she will have retired by the time the school faces compensatory penalties.
The second plank of the accountability system aims to solve the time-lag problem. Institutions will be required to provide a financial guarantee against future risk-sharing payments. An institution may elect to defer a portion of its federal student loan disbursement until it demonstrates positive student outcomes. Alternatively, it may secure third-party insurance coverage against future risk-sharing liabilities. Unless it invests in producing good outcomes today, the institution will no longer enjoy unfettered access to federal loans.
Risk-sharing and financial guarantee requirements are both proverbial “sticks”: they represent new financial burdens for institutions that produce subpar outcomes. However, federal policy should also provide “carrots” to reward institutions that produce excellent results for low prices. Financial rewards for high-quality programs provide the incentives and the fiscal capacity for institutions to expand programs with proven track records of success.
Financial rewards for high-quality programs provide the incentives and the fiscal capacity for institutions to expand programs with proven track records of success.
To that end, the accountability system reinvests risk-sharing revenues into bonus Pell Grants for programs where graduates enjoy high earnings for low prices. Channeling these funds into Pell Grants — which provide financial aid for low- and middle-income undergraduate students — will encourage institutions to enroll more disadvantaged students in high-quality programs. The extra Pell Grant funding will help students afford good programs and provide the fiscal space for colleges to expand them.
The following sections detail each component of the accountability plan and model their effects on higher education programs.
Part One: Student loan risk-sharing
Whether or not a student pays down her loans is strongly correlated with the ROI of the program she attended. When students enrolled in a given program do not make significant progress paying down their loans — or worse, fail to pay down their loans at all — the institution offering that program should compensate taxpayers for a portion of the unpaid loan balance.
Such a risk-sharing policy defrays costs to the government. But more importantly, risk-sharing provides a financial incentive for colleges to help their students succeed economically. To avoid paying compensation, colleges must provide a high-value education.
As loan repayment rates fall, compensation requirements rise: programs in which students make less progress on their loans face stiffer risk-sharing liabilities. In contrast to the all-or-nothing enforcement mechanism of current accountability rules, a graduated compensation requirement encourages continuous improvement. Programs with mediocre but not disastrous outcomes still receive a nudge to improve rather than a rubber stamp of approval once they surpass some arbitrary threshold.
In contrast to the all-or-nothing enforcement mechanism of current accountability rules, a graduated compensation requirement encourages continuous improvement.
To implement risk-sharing, the Education Department measures the volume of loans associated with each program that enters repayment in a given fiscal year. Five years later, ED determines how much of that original balance has been repaid. It then compares actual repayment outcomes to a threshold consistent with full repayment of the loan. If the real-world repayment rate exceeds the threshold, students in that cohort are on track to repay their loans in total, so there is no compensation requirement. But if repayment falls short of the threshold, the college must reimburse taxpayers for a portion of the unpaid balance.
If students are making some progress, but not enough to fully repay their debts in a timely manner, the risk-sharing liability is moderate. A small compensation requirement will nudge institutions towards lowering prices or improving outcomes. But if students in a given cohort fail to pay down their loans at all, the institution must reimburse taxpayers for a much larger amount. For many schools, such liability will be severe enough to make operating the program using federal student loans financially untenable. Schools with such abysmal outcomes must either close their nonperforming programs or seek financing outside the federal loan system.
Student loan risk-sharing: how it works
The risk-sharing system in this paper is a modified version of one proposed by Tiffany Chou, Adam Looney, and Tara Watson in a 2017 Brookings Institution report. Key differences include calculating loan repayment rates at the program (rather than institutional) level and adjusting the penalty schedule.
Step 1: Construct cohorts
The Education Department divides federal student loans into cohorts based on the institution the associated student attended, the program they graduated from, and the fiscal year they entered repayment. Programs are defined at the 4-digit Classification of Instructional Programs (CIP) code level. For instance, one cohort consists of all loans associated with students who completed a bachelor’s degree in psychology at the University of Arizona and entered repayment in fiscal year 2023.
ED also constructs additional cohorts for students who received loans at a given institution but did not complete a credential and thus cannot be assigned to a program. Separate cohorts are created for undergraduate and graduate loans. For example, undergraduate loans associated with students who attended the University of Arizona, did not complete a credential, and entered repayment in fiscal year 2023 comprise one cohort. ED constructs a separate cohort for all Parent PLUS loans associated with a given institution that enter repayment each year.
For each cohort, ED measures the total loan volume entering repayment, including both principal and interest accrued while in school.
Step 2: Calculate repayment rates
At the end of the fifth full fiscal year after a cohort enters repayment, ED measures the total volume of principal and interest that remains outstanding on the loans. For example, for a cohort entering repayment in fiscal year 2023, outstanding loan volume is measured at the end of fiscal year 2028. Any unpaid interest forgiven through an income-based repayment plan, such as the new plan proposed by President Biden in August 2022, is added to this total.
The sum of current outstanding balance and forgiven unpaid interest (COBI) is then divided by the original loan volume at repayment. The quotient is the percentage of the original balance that has not been repaid five years later. Subtracting the quotient from 100 percent yields the five-year cohort repayment rate (CRR5).
Cohort Repayment Rate = 100% — (Current Outstanding Balance + Forgiven Unpaid Interest) / (Loan Volume at Repayment)
For example, if a cohort’s original balance entering repayment is $1,000,000 and borrowers pay down a net $50,000 worth of principal, then COBI is $950,000 and CRR5 is 5 percent. If the total balance (including forgiven interest) rises, then CRR5 is negative.
Step 3: Calculate required compensation
ED determines the required compensation for a program based on how far CRR5 falls short of a repayment benchmark of 10 percent. The 10 percent benchmark corresponds to the cohort repayment rate at which a cohort of borrowers would be on track to fully pay off their loans within 20 years, assuming the maximum student loan interest rate allowed by law. After 20 years, most borrowers on income-based repayment plans receive a discharge of their remaining debts, so borrowers on track to pay off their loans before the 20-year mark will usually repay in full.
If CRR5 exceeds 10 percent, the cohort is roughly on track to repay its loans. No program whose students pay off loans in full should ever face a risk-sharing liability. Therefore, programs where CRR5 is greater than 10 percent will not need to compensate taxpayers.
If CRR5 is less than 10 percent but greater than zero, the cohort is making progress on its loans but not enough to fully repay within 20 years. Programs in this category have potential but need a nudge to improve repayment outcomes. Therefore, the school must compensate the government for an amount equal to 0.5 percent of COBI for every percentage point that CRR5 falls short of the 10 percent benchmark. For instance, if CRR5 is seven percent and COBI is $930,000, then the school owes (10–7) * (0.005) * ($930,000), or $13,950.
If CRR5 is less than zero but greater than negative 10 percent, the cohort is negatively amortizing to a moderate degree. The economic value of programs in this category is questionable, but there may be hope. The school must compensate the government for an amount equal to five percent of COBI, plus an additional one percent for every percentage point that CRR5 falls short of zero. For instance, if CRR5 is negative 6 percent and COBI is $1,060,000, then the school owes (0.05 + 0.01 * (0 - -6)) * ($1,060,000)), or $116,600.
If CRR5 is below negative 10 percent, the cohort is negatively amortizing to an extreme degree. As these programs are essentially hopeless, ED should assess a heavy penalty to make them financially untenable for institutions to operate. The school must compensate the government for an amount equal to 15 percent of COBI, plus five percent for every percentage point that CRR5 falls short of negative 10 percent. For instance, if CRR5 is negative 18 percent and COBI is $1,180,000, then the school owes (0.15 + 0.05 * (-10 - -18)) * ($1,180,000), or $649,000.
Penalties are capped at 100 percent of the original loan disbursement associated with the cohort.
The following chart illustrates the penalties that different five-year cohort repayment rates would trigger on a cohort whose loan volume upon entering repayment was $1,000,000. Positive cohort repayment rates below 10 percent will trigger minimal penalties relative to the balance at repayment. But when CRR5 drops below zero, penalties rise considerably. Institutions facing penalties of this size will see little financial advantage in continuing to offer the associated programs using federal student loans.
Step 4: Collect compensation
The institution (or a third-party financial institution it has designated; see next section) must compensate taxpayers for the sum of all risk-sharing liabilities associated with its programs, as well as liabilities related to the Parent PLUS and non-completer cohorts. If the compensation requirement for a given program exceeds the financial guarantee the institution has supplied for that program, the institution may waive the portion of that liability not covered by the financial guarantee.
However, if institutions choose to waive liability in this way, they may not use federal loans to enroll new students in that program for ten full academic years from the date the compensation was due. If required compensation exceeds the financial guarantee, then taxpayers are facing such steep losses on that program that it should no longer be eligible for federal loans.
Students enrolled in such a program when the institution waives a liability may continue to access federal student loans until they are separated from the institution. Institutions may pick and choose which programs they wish to withdraw from federal student loans; if a school withdraws its music program, there will be no effect on loan access for engineering students. Schools may also continue to access Pell Grants even if they withdraw a program from federal loans.
Similarly, the institution may waive uncovered liabilities associated with its Parent PLUS cohort if it agrees to withdraw from Parent PLUS loans entirely. Moreover, the institution may waive uncovered liabilities associated with non-completer cohorts if it withdraws all its programs from federal student loans. More details on waivers are available in the next section and the Appendix.
How student loan risk-sharing would affect higher education
Estimating the required compensation that various higher education institutions would pay under a risk-sharing regime is inherently difficult. Current data on student loan repayment rates at the program level are patchy. Moreover, the Biden administration’s new income-based repayment plan will slash future payments and thus obsolete most existing data on how quickly borrowers pay down their loans.
However, it is possible to derive a rough estimate of program-level cohort repayment rates using existing data on graduates’ debt levels and post-graduation earnings. To construct cohort repayment rates, I assume that most borrowers use the new income-based repayment plan, which caps loan payments at five percent of income for undergraduate borrowers and 10 percent for graduate loans above 225 percent of the federal poverty line. However, a minority of borrowers still choose the standard ten-year repayment plan as they wish to discharge their debts as quickly as possible. (The share choosing the standard plan varies by program but averages around one-fourth.)
This approach has caveats. It is inherently difficult to predict borrower behavior under a repayment regime that does not yet exist. The model does not account for the possibility that some borrowers might prepay their loans (raising CRR) or become delinquent (lowering CRR). Given data limitations, it is necessary to model repayment outcomes for the median borrower in each program, but borrowers with exceptional levels of debt or earnings may have an outsize impact on their program’s CRR. Moreover, institutions may change their behavior to avoid liabilities — indeed, this is the central goal of the risk-sharing plan — but that is not accounted for in the following modeling.
Risk-sharing would target programs with low ROI
At the median, schools will need to compensate taxpayers for an amount equal to $1,000 per borrower. However, required compensation varies considerably by program, corresponding to the wide variation in costs and outcomes. Thirty-six percent of programs will trigger no compensation requirement, while roughly a quarter will pay a penalty exceeding $5,000 per borrower.
Nearly all programs with a negative financial return will face at least some risk-sharing liabilities, and two-thirds will pay more than $5,000 per borrower.
Required compensation is strongly correlated with FREOPP’s estimates of ROI. Nearly all programs with a negative financial return will face at least some risk-sharing liabilities, and two-thirds will pay more than $5,000 per borrower. On average, institutions offering negative-ROI programs will be required to compensate taxpayers for 50 percent of the loan amount disbursed to borrowers in that program. Liabilities of this size will be financially untenable for most institutions, and schools will find it advantageous to shutter these negative-ROI programs entirely.
Meanwhile, most programs with lifetime ROI surpassing half a million dollars will not trigger compensation requirements at all. High-ROI programs provide their students with exceptional earnings outcomes for a relatively low cost. This is a standard to which all colleges and universities should aspire.
While a small share of high-ROI programs face compensation requirements, the amounts are usually modest: less than $1,000 per borrower in most cases. Such small liabilities will not be financially prohibitive for institutions. Instead, they will function as a nudge for institutions with high-value but expensive programs to lower tuition, and hence student debt levels.
Programs in the middle of the ROI distribution present the most interesting cases. A program with low but positive ROI will trigger a moderate compensation requirement. The median liability for a program with ROI between $0 and $500,000 is $1,900 per borrower, which equates to roughly 11 percent of original loan disbursements.
Colleges cannot ignore a financial liability of this size. However, they are most likely to respond by attempting to improve such programs, perhaps by lowering tuition, revamping curricula to emphasize labor market-relevant skills, or providing better career services to boost graduates’ chances of landing a decent job. While these programs fall somewhat short of the high standard taxpayers should expect for their investment, they have potential. Colleges should see more value in improving these programs than closing them entirely.
The use of graduated compensation requirements allows institutions to improve their programs to reduce or eliminate their risk-sharing payments.
Unlike accountability policies such as the Cohort Default Rate and Gainful Employment, the risk-sharing system does not automatically shut down programs below some arbitrary threshold. Rather, the use of graduated compensation requirements allows institutions to improve their programs to reduce or eliminate their risk-sharing payments. Additionally, programs with mediocre but not abysmal outcomes do not escape accountability: despite facing moderate liabilities, there is still a clear financial incentive to improve.
Part Two: Financial guarantee
Student loan risk-sharing holds colleges accountable for student outcomes. However, those outcomes take a long time to be realized. For example, a college freshman might see his first student loan disbursed in fall 2022. He graduates in 2026 and enters repayment in fiscal year 2027. His loan outcomes are measured five years later, at the end of fiscal year 2032. There is a ten-year lag between this borrower’s first loan disbursement and when the institution must compensate taxpayers for loan losses. For reference, the average college president’s tenure is fewer than seven years.
The goal of risk-sharing is not simply to collect compensation for unpaid loans, although that is an advantage. Rather, risk-sharing should encourage this institution to make decisions in fall 2022, when this student first enrolls, that will improve his outcomes in 2032. Such decisions could include lowering prices, offering a different mix of programs, or emphasizing career-relevant skills. But these actions come with costs, and decisionmakers at colleges and universities may be hesitant to absorb such costs upfront to avoid penalties down the road.
It is critical to ensure that colleges have skin in the game on student outcomes before those outcomes are even realized. As a condition of participating in federal student loans, institutions should be required to provide a financial guarantee against potential risk-sharing liabilities they may incur in the future. No federal loan should be disbursed without a guarantee that the institution will compensate taxpayers for possible losses on that loan. In essence, colleges should only be paid in full once they demonstrate satisfactory outcomes.
Institutions may satisfy this financial guarantee requirement in one of two ways: deferred payment or insurance.
Under deferred payment of federal student loans, the institution does not receive the total amount of the loan when it is originated. Instead, ED holds back a percentage of the loan until repayment outcomes are assessed. If the institution is required to compensate taxpayers for unpaid loans, then ED subtracts the compensatory penalty from the deferred portion of the loan and releases the remaining funds to the school.
Naturally, institutions will object that they need all their student loan funding upfront to provide a high-quality education. Therefore, they will have a second option to supply the financial guarantee: third-party insurance. Institutions may receive the full loan upfront if they secure insurance from a private, third-party financial institution to cover potential risk-sharing penalties. Schools that have confidence that they will not face risk-sharing liabilities must convince an insurance company of this fact to receive all their funding upfront.
Under such an arrangement, the school pays a premium to the insurance company to cover potential risk-sharing liabilities associated with a loan. If the school owes compensation to taxpayers, then the insurance company pays the government directly on behalf of the school. Insurance companies will charge schools higher premiums to insure programs where they expect worse outcomes. To lower its premiums, the school must make changes on the front end to improve students’ prospects.
Insurance requirements have precedent in other federal government programs. Homeowners with certain FHA-backed mortgages must pay a mortgage insurance premium to cover lenders’ losses in the event of a default. Insurance requirements for colleges function in a similar manner: the college must supply a financial guarantee to cover the government’s losses in the event students cannot pay back their loans.
The college must supply a financial guarantee to cover the government’s losses in the event students cannot pay back their loans.
Risk-sharing is not intended to overwhelm institutions with financial liabilities. Rather, the risk-sharing framework and the financial guarantee should work in concert to nudge institutions to wind down low-ROI programs before the institution is ever liable for a compensatory penalty. To that end, the guarantee requirement is phased in slowly so that institutions are not immediately overwhelmed with a significant interruption in their revenue streams. Moreover, institutions will be allowed to waive a portion of their risk-sharing penalties if they agree to withdraw penalized programs from federal loans.
Financial guarantee: how it works
Institutions can satisfy the financial guarantee requirement by either deferring a portion of their loan payments from ED or purchasing insurance. ED will automatically assign each institution the deferred-payment option unless the school actively elects the insurance option.
Deferred payment option
Under this proposal, when a federal student loan is originated, ED releases only a portion of the loan upfront. The percentage of the loan held back depends on the size of the required financial guarantee, which varies according to a phase-in schedule (see below). For example, if a student borrows $5,000 to attend an institution and the required financial guarantee is 25 percent, only 75 percent of the loan is released upfront. The institution receives $3,750 at origination, while the other $1,250 is deferred.
The financial guarantee makes no difference from the student’s perspective. Even though only $3,750 is released upfront, the student still owes the entire $5,000 loan as soon as the upfront portion is paid out. The institution must calculate the student’s financial aid and net price as if the loan had been fully disbursed. In other words, it must apply the full $5,000 to the student’s tuition bill. The student is still borrowing $5,000 and the institution is still receiving $5,000; the only difference is the timing of when ED supplies the funds to the institution.
ED holds back the remaining $1,250 until it determines whether the college must compensate taxpayers for losses on the loan. If the institution faces no risk-sharing liability, ED returns the full $1,250 to the institution. If the risk-sharing liability associated with that loan is smaller than the deferred portion, then ED returns the difference to the institution; a risk-sharing penalty of $500 means ED returns just $750 to the institution. If the penalty exceeds the deferred portion of the loan, then the institution owes money to ED.
Insurance option
Institutions that do not wish to participate in deferred payments may opt-out at any time by purchasing insurance to cover potential risk-sharing liabilities. The amount of required insurance coverage is equal to the deferred portion of the loan. Continuing the previous example, if the deferred portion of the loan is $1,250, then the institution must purchase insurance to cover a risk-sharing liability of up to $1,250. Once this coverage is secured, ED releases the remaining $1,250 to the institution.
There is no time limit constraining the institution’s ability to choose this option. It may purchase insurance coverage as soon as the loan is originated, which allows ED to release the entirety of the loan upfront. Alternatively, the institution may wish to wait a few years until the student has graduated and the risk of nonpayment has fallen (graduates repay student loans at much higher rates than dropouts). Insurance coverage may be cheaper to secure at this juncture, but the institution will still be able to access the remainder of the money a few years early.
When risk-sharing liabilities are determined, the insurance company will be the first to pay ED, up to the amount of coverage the institution has secured. The company pays the entire penalty if the penalty is smaller than the coverage amount. (Nothing is returned to the institution, as the loan was released in full when the institution secured insurance coverage.) If the penalty exceeds the coverage amount, the institution must pay the difference directly to ED.
Phase-in
Deferred loan payments and insurance coverage for risk-sharing liabilities are relatively new ideas in higher education. While they have promise as mechanisms to sharpen incentives for colleges to improve outcomes, it will take time for the higher education system to adapt. Therefore, the size of the required financial guarantee (the deferred portion of the loan or the insurance coverage requirement) starts at a very low level and scales up over time.
The phase-in period will give colleges time to adapt to the deferred-payment system, and the risk-sharing insurance market will have time to mature. Institutions will be able to make necessary changes to improve programs’ outcomes before the burden of the financial guarantee becomes too great. Moreover, schools may identify programs with little hope of bringing their outcomes up to standard, and they will have ample time to wind down these programs with dignity.
The phase-in period will give colleges time to adapt to the deferred-payment system, and the risk-sharing insurance market will have time to mature.
In the first academic year of the risk-sharing regime, institutions must provide a financial guarantee equal to just 2.5 percent of federal student loan disbursements. This means either deferring 2.5 percent of each loan disbursed in the first academic year or securing insurance coverage equal to 2.5 percent of loan disbursements. Such a low guarantee requirement will not be financially ruinous for the institution; it will have time to adapt.
In the second academic year of the risk-sharing regime, the size of the financial guarantee rises to 5 percent of loan disbursements. In the following years, the required financial guarantee as a share of disbursements rises according to the following schedule: 7.5 percent in the third year, 10 percent in the fourth year, 12.5 percent in the fifth year, 15 percent in the sixth year, 20 percent in the seventh year, 30 percent in the eighth year, 40 percent in the ninth year, and 50 percent in the tenth year and all years after that.
Penalty waivers
Risk-sharing liabilities are capped at 100 percent of the original loan disbursements associated with that cohort. Therefore, a cohort’s risk-sharing liability may exceed the amount of the financial guarantee, which tops out at 50 percent of disbursements. When this occurs, the institution must pay ED the uncovered portion of the penalty directly. For example, if a program triggers an $80,000 risk-sharing liability but the institution has provided a financial guarantee of only $50,000, the institution owes ED $30,000.
That $30,000 is the “uncovered” portion of the institution’s liability. During the phase-in, it is likely that some institutions will be liable for significant uncovered liabilities on specific programs due to the relatively small size of the financial guarantee requirements in the early years. To repeat: the goal of risk-sharing is not to ruin institutions financially. Rather, policymakers should create incentives for institutions to wind down programs that may be subject to severe risk-sharing liabilities.
The goal of risk-sharing is not to ruin institutions financially. Rather, policymakers should create incentives for institutions to wind down programs that may be subject to severe risk-sharing liabilities.
To that end, an institution may waive uncovered liabilities for a particular program if it agrees not to enroll new students using federal student loans in that program for ten full academic years from the date the risk-sharing penalty is assessed. (Liabilities covered by a financial guarantee may never be waived.)
Students enrolled in the program when the penalty is assessed may finish their degrees using federal loans. The institution may continue to operate the program, but it must seek funding from sources outside federal student loans, such as private philanthropists, employers, or state governments.
Institutions will find it advantageous to wind down programs that they suspect will be subject to severe uncovered risk-sharing liabilities. While this will temporarily cost the government revenue in the form of lost compensation on unpaid loans, the long-term benefits will be worth it: institutions will voluntarily withdraw programs where students do not repay their debts. This means fewer losses on future student loans and fewer borrowers stuck with debt they cannot afford.
It is likely that institutions will choose to wind down low-quality programs well before risk-sharing penalties are even assessed. Institutions that wait longer will face larger financial guarantee requirements, meaning the portion of risk-sharing liabilities they can waive will diminish. This creates a significant front-end financial incentive for schools to shift enrollment from low-quality programs to high-quality ones, meaning students will see the benefits of risk-sharing long before the first penalty is assessed.
Part Three: Pell Grant bonus
The first two components of this proposed accountability system — student loan risk-sharing and financial guarantees from colleges — will incentivize better outcomes and present new financial burdens for institutions that rely on federal aid. The third component of this proposal continues to encourage high standards, but by rewarding good outcomes rather than punishing bad ones. If risk-sharing is a stick, Pell Grant bonuses are a carrot.
The Pell Grant is the federal government’s flagship financial aid program for low- and middle-income undergraduate students. It provides up to $6,895 per year that students can use for college. Unlike loans, the grant does not have to be repaid. The grant is means-tested: a student in a four-person family with a household income of $35,000 qualifies for the maximum Pell Grant of $6,895. But a student from a similar family with a household income of $65,000 qualifies for a smaller Pell Grant of $2,245.
Higher education advocates push for increases in the Pell Grant to defray college costs for students with fewer financial resources. Unlike student loans, which are open to students from all walks of life, the Pell Grant aims to level the playing field between richer and poorer students.
However, the Pell Grant also represents a $28 billion annual expenditure for taxpayers with very few strings attached; institutions receiving Pell Grants are not required to demonstrate any objective student outcomes. Moreover, there is evidence that larger Pell Grants lead schools to raise prices and cut back on other forms of financial aid. Increasing Pell Grants without other reforms, therefore, runs the risk of funding expensive schools that do too little to place their graduates on a sound financial footing.
Increasing Pell Grants without other reforms runs the risk of funding expensive schools that do too little to place their graduates on a sound financial footing.
This white paper proposes boosting the federal Pell Grant, but only for programs where students’ earnings after completion justify the price they paid. Programs that deliver exceptional outcomes for a modest cost will become eligible for up to a $5,000 increase in the maximum Pell Grant. But programs where earnings are not high enough to justify college costs will receive no additional Pell funding.
Additional Pell dollars for high-quality programs will encourage students to choose fields of study that lead to a decent career. While institutions may capture a portion of additional Pell funding, this is not necessarily a bad thing because that additional funding is tied directly to outcomes. Research shows that many universities cap the number of students who can enroll in high-value majors like computer science and nursing. Even if it is partially captured, the extra Pell funding will give institutions both the incentive and fiscal capacity to expand enrollment in their highest-quality programs.
Tying government funding for higher education to student outcomes, particularly graduates’ earnings, is a growing model that has seen great success at institutions such as Texas State Technical College. After the school moved to outcomes-based funding in 2013, completions rose by 48 percent and graduates’ earnings rose by 26 percent. The college accomplished this by expanding programs that produced better outcomes for graduates and closing programs that did not perform up to standard. The federal government can replicate that successful model at colleges across the country by tying an increase in Pell Grant funding to student earnings.
Pell Grant bonus: how it works
Each year, the Education Department calculates a Pell Grant bonus for all higher education programs for which data are available. Programs where graduates’ earnings are higher relative to their out-of-pocket costs receive more significant bonuses. All the data necessary to calculate these bonuses currently exist, so ED may provide bonuses in the first academic year following the implementation of the accountability system.
Step 1: Calculate surplus earnings
For each higher education program with a graduate cohort size large enough to gather data, ED calculates the median earnings of program completers in the third full calendar year after completion. Earnings data come from IRS tax records, much as the College Scorecard’s earnings data does today. ED and the IRS may combine up to three consecutive cohorts of completers for a given program to obtain a statistically meaningful sample size.
Once ED has median earnings in hand, it adjusts them according to the Bureau of Economic Analysis’ regional price parity index for states. This reflects the fact that wages and the cost of living vary across states: a $45,000 salary in Mississippi is much higher in real terms than a $45,000 salary in California. ED then subtracts 300 percent of the federal poverty line for a single person in the year that earnings were measured to calculate surplus earnings.
Surplus Earnings = ( Median Earnings / (Regional Price Parity / 100) ) — 300% of Federal Poverty Line
Consider a program at a community college in Ohio where graduates earn a median salary of $45,000 three years after completion. According to the Bureau of Economic Analysis, Ohio’s regional price parity index value is 91.7, meaning that a basket of goods that costs $100 on average nationally cost only $91.70 in Ohio. ED divides the nominal earnings of $45,000 by 0.917 to yield adjusted earnings of $49,073. It then subtracts 300 percent of the federal poverty line ($40,770) to compute surplus earnings of $8,303.
Step 2: Calculate price paid
For each program, ED calculates the sticker-price tuition and required fees that students in that cohort were required to pay to earn all the credits necessary to complete their degree. This figure, the “all-in price,” may be calculated as full-time, full-year tuition and fees for the academic year in which the cohort graduated times the number of academic years (or portions of academic years) required to complete the program. For instance, if a bachelor’s degree program charges $10,000 in tuition and required fees and students must enroll full-time for four years to complete all required credits, the all-in price is $40,000.
For institutions that charge differential tuition by residency, ED should use a weighted average of tuition for students paying the resident and nonresident rates. ED may request that institutions supply data on required tuition and fees, program lengths, and enrollment by residency. As this information is used to calculate Pell Grant bonuses, institutions can only benefit from supplying the data. Institutions that refuse to provide pricing data will not be eligible for the Pell Grant bonus.
Some institutions may object that they provide significant financial aid to their students, and therefore sticker-price tuition and fees is not a fair representation of the prices students actually pay. If this is the case, institutions may substitute average net tuition after institutional grants but before government- and employer-provided aid; average net tuition can then substitute for published tuition in calculating the all-in price. However, the onus will be on institutions to document their average net tuition to the satisfaction of ED.
Step 3: Calculate Pell Grant bonus
For each program, ED calculates the ratio of surplus earnings to all-in price (the earnings-price ratio, or EPR). For instance, if surplus earnings are $8,000 and the all-in price is $20,000, EPR is $8,000/$20,000, or 0.4. Programs with higher earnings will have a higher EPR and vice versa, while programs with higher prices will have a lower EPR. EPR may therefore be thought of as a measure of the economic value a program provides relative to its cost.
Earnings-Price Ratio = Surplus Earnings / All-In Price
If EPR is less than or equal to zero, the program will receive no Pell Grant bonus. Students in such programs will continue to be eligible for the base Pell Grant.
If EPR is greater than zero but less than one, the program will receive a Pell Grant bonus equal to $5,000 times EPR. For instance, a program with an EPR of 0.4 will receive a Pell Grant bonus of $2,000.
If EPR is equal to or greater than one, the program will receive a Pell Grant bonus of $5,000. The maximum Pell Grant bonus of $5,000 should be indexed to rise with inflation over time.
Step 4: Implement Pell Grant bonus
Going forward, students who enroll in a specific program are eligible for larger Pell Grants if that program qualifies for a Pell Grant bonus. Specifically, students’ Pell awards are calculated as if the maximum Pell Grant were the base Pell Grant plus the bonus. For instance, in 2022–23 the maximum base Pell Grant is $6,895. If a particular program is eligible for a Pell Grant bonus of $3,000, students in that program have their Pell award calculated as if the maximum Pell Grant were $9,895.
Students currently eligible for a Pell Grant see their Pell aid increased by the Pell bonus. This will benefit lower-income students who choose high-value programs.
The upshot is that students currently eligible for a Pell Grant see their Pell aid increased by the Pell bonus. This will benefit lower-income students who choose high-value programs. Middle-income students who are currently just above the cutoff for Pell eligibility will also see a benefit. For instance, a student in a four-person family with a household income of $75,000 is not currently eligible for a Pell Grant. But if she enrolls in a program with a Pell Grant bonus of $3,000, she will receive an award of $2,870.
ED calculates Pell Grant bonuses every year as new cohorts’ data come in. If the bonus for a particular program rises, enrolled students can enjoy the higher bonus. However, if the bonus for a program falls, students may continue to receive the same Pell Grant bonus so long as they maintain continuous enrollment. If a student switches programs, her Pell award changes to reflect the bonus associated with the new program. Before declaring a major, students will only be eligible for the base Pell Grant.
Pell Grant bonuses will support programs with strong outcomes and low costs
Through the College Scorecard and data requests from institutions themselves, ED should be able to calculate and implement Pell Grant bonuses in the first academic year following the establishment of the accountability system. Implementing the carrot — Pell Grant bonuses — at the same time as the sticks — risk-sharing and financial guarantees — will give institutions a double incentive to improve outcomes, and provide extra fiscal space for institutions to make necessary changes.
Indeed, data is already available for many programs, so it is possible to calculate Pell Grant bonuses on an informational basis. Among 27,000 undergraduate programs for which data are available, the average Pell Grant bonus would be $1,100. Sixty-one percent would receive at least some Pell Grant bonus. Eight percent would be eligible for the maximum bonus of $5,000.
To become eligible for a Pell Grant bonus, a program must raise its students’ median earnings above 300 percent of the federal poverty line, or $40,770 in 2022.
To become eligible for any Pell Grant bonus, a program must raise its students’ median earnings above 300 percent of the federal poverty line, or $40,770 in 2022. As a result, more bachelor’s degree programs are eligible for a Pell Grant bonus than associate degree and certificate programs. But once a program reaches this threshold, the Pell Grant bonus rises faster if the all-in price is lower. Because they have shorter durations and lower tuition, associate degrees and certificates are far more likely to qualify for the maximum Pell Grant than bachelor’s degrees.
The Pell Grant thus rewards subbaccalaureate programs with a proven track record of quickly launching their graduates into the middle class. Schools offering bachelor’s degrees can benefit, but only if they keep costs down.
Consider Texas A&M University-College Station and the University of Notre Dame. Both schools offer business degrees where graduates earn an impressive $78,000 three years after completion. But Texas A&M charges resident students just $13,000 per year in tuition and required fees, while Notre Dame charges a whopping $60,000. As a result, Texas A&M’s business program qualifies for a Pell Grant bonus of $4,490, while Notre Dame’s program receives a Pell Grant bonus of just $1,215.
The Pell Grant bonus also rewards students who choose higher-return majors within the same institution. A business student at Texas A&M qualifies for a Pell Grant bonus of $4,490. If she also qualifies for the maximum Pell Grant, the base Pell Grant plus the bonus will almost fully cover tuition at Texas A&M. But if this student switches her major to political science, her Pell Grant bonus drops to $875. If she changes her major to philosophy, she will receive no Pell Grant bonus, though she may continue to access the base grant.
A systematic analysis of Pell bonuses shows they support programs with strong ROI. Nearly all undergraduate programs with a financial return above $500,000 enjoy at least some Pell Grant bonus, and many qualify for the maximum bonus. As ROI falls, however, fewer programs receive a bonus. The vast majority of negative-ROI programs receive no bonus at all.
In addition to encouraging students to choose high-value majors, the Pell bonus will incentivize schools to invest in high-quality programs. Colleges and universities have been among the foremost advocates for increasing the maximum Pell Grant. If they want the extra money, they should produce results consistent with the high standards taxpayers expect from their investment in postsecondary education.
Institutional failsafe
Data limitations mean that program-level earnings must necessarily reflect program completers only. Some schools with low completion rates may post decent results for graduates even as the vast majority of students drop out. To address the risk that Pell bonuses may fund dropout factories, schools with abysmal earnings outcomes for all former students should not be eligible for Pell Grants.
To that end, Congress should eliminate Pell Grants for institutions where the RPP-adjusted median earnings of all students (completers and dropouts combined) three years after separation from the institution falls below 150 percent of the federal poverty line for a single person ($20,385 in 2022). This threshold is well below typical earnings for early-career high school graduates and is the level at which pre-Biden versions of income-based repayment plans declared borrowers too poor to repay their loans.
At schools with high completion rates, median earnings for all students will closely track program-level earnings. But at schools with low completion rates, median earnings for all students could fall well short of program completers’ earnings. Eliminating Pell Grants for institutions with exceptionally poor outcomes is a necessary failsafe to ensure that schools benefitting from Pell Grant bonuses deliver decent completion rates for the programs that taxpayers fund.
Currently, fewer than three percent of institutions would lose access to Pell Grants under such a change. While the immediate impact of the failsafe will be small, it will also prevent institutions from expanding enrollment to exploit additional Pell dollars without helping those new students graduate.
Additional policy recommendations
The accountability system described in this white paper is meant to stand apart from other significant changes to higher education policy. Though we have proposed changes such as limiting federal graduate student loans and reforming income-based repayment plans, those changes are not strictly necessary to make the accountability system work. However, we recommend the following minor changes to make the accountability system fair and effective. Additional details are available in the Appendix.
Enshrine income-based repayment into statute. Current law gives the executive branch wide latitude to change the terms of income-based repayment (IBR) plans without Congressional approval. The Biden administration recently issued a proposed regulation that would create an IBR plan with extremely generous terms. When ED makes a new IBR plan, current and future borrowers are generally eligible. By slashing student loan payments, ED can reduce cohort repayment rates post hoc. This means that ED can theoretically increase an institution’s risk-sharing liabilities after student loans have been disbursed.
This is not fair to institutions, which may see risk-sharing liabilities spike even if the underlying quality of their education has stayed the same. To address this problem, Congress should enshrine the terms of income-based repayment and other repayment plans into law and prohibit ED from modifying them without legislative approval. Though the risk-sharing system in this white paper was designed with Biden’s new IBR plan in mind, the exact terms of the IBR plan Congress enshrines are less important than the certainty that those terms will not change.
If Congress does wish to change the terms of IBR after implementing the risk-sharing system, it should make only new borrowers eligible for the updated IBR plan.
Allow institutions to limit borrowing. Currently, students may take out federal loans up to statutory limits. These limits effectively do not exist for the Grad PLUS and Parent PLUS programs. While institutions set their tuition and thus heavily influence how much students borrow, some students can run up large debts for living expenses. Debts incurred for non-tuition expenses are outside the institution’s control, so some students may borrow more than they can reasonably repay. Under a risk-sharing system, some institutions may be liable for losses on loans they had little responsibility for.
Therefore, institutions should be allowed to reduce loan limits below the statutory limit for their own students. While institutions should not be allowed to deny federal loans to individual students selectively, they should be able to set a lower loan limit for all students in a particular program.
Limit forbearances. Student borrowers are entitled to place their loans into discretionary forbearance for up to three consecutive years; during this time, interest will accrue, but students are not required to make payments. Long-term forbearances are becoming a more popular option. The Government Accountability Office found that between 2009 and 2013, 20 percent of borrowers were in forbearance for 18 months or longer.
New benefits such as income-based repayment make long-term forbearances unnecessary since borrowers in financial distress are always guaranteed an affordable payment. Therefore, Congress should limit discretionary forbearances to three months without the possibility of renewal so that borrowers who have the financial capacity to pay down their loans have little option to avoid doing so. Limits on forbearances will ensure that student loan payments reflect the economic value of the programs they financed.
In addition, Congress should bar the executive branch from placing student borrowers into administrative forbearance en masse, as occurred during the COVID-19 pandemic. Institutions should not be liable for student loan nonpayment that comes about as a result of a mass student loan payment pause.
Additional considerations
This section addresses some common questions and concerns about student loan risk-sharing and higher education accountability.
How would higher education accountability impact the deficit?
The accountability plan proposed in this white paper would claw back losses on federal student loans, but also increase spending on Pell Grants. Using the average risk-sharing penalty per borrower, the percentage of students who borrow, and the number of students who complete a degree every year, I estimate that risk-sharing assessments would, in the long run, raise $13.6 billion per year. By contrast, the Pell Grant bonus would cost $7.5 billion per year. The accountability plan will thus reduce the deficit by approximately $6 billion annually.
The accountability plan will reduce the deficit by approximately $6 billion annually.
The actual deficit impact may be even larger. The above calculations do not account for risk-sharing assessments on non-completer and Parent PLUS cohorts. Moreover, severe risk-sharing penalties will induce some schools to withdraw programs from federal loans. If the government does not fund these programs anymore, it cannot suffer those associated losses. This could add to the savings derived from the risk-sharing assessments.
The calculations do not account for the possibility that students will switch from low-ROI to high-ROI programs. While switching will increase expenditure on the Pell Grant bonus, it will also increase loan repayment rates and income tax revenues, likely compensating for the increased spending on Pell Grants.
How will accountability impact different institutions?
One virtue of program-level rather than institution-level accountability is that it recognizes that different degrees at the same institution create vastly different labor market value. However, it is also possible to analyze average risk-sharing liabilities for groups of institutions to determine which types of schools are most affected.
For-profit colleges face the highest average risk-sharing liabilities. Proprietary schools will pay $4,100 per graduate at four-year institutions and $5,600 per graduate at two-year institutions. Private nonprofit universities that grant doctoral degrees will also pay a significant penalty of $3,200 per graduate. However, around half of programs at these schools trigger no risk-sharing liability, suggesting there is considerable scope for these schools to change the mix of programs they offer to avoid penalties.
Public community colleges have the lowest average risk-sharing liability, at just $500 per graduate. Community colleges are also most likely to receive the maximum Pell Grant; 27 percent of programs at these schools qualify for a bonus of $5,000. Community colleges offering high-value programs will benefit the most from this accountability system.
Meanwhile, most undergraduate programs at four-year public and private nonprofit universities qualify for at least some Pell bonus, though very few receive the maximum.
Will risk-sharing lead schools to discriminate against low-income students?
One objection to risk-sharing is that it will lead colleges to reject students whom they anticipate will have poor loan repayment outcomes — namely, low-income and underrepresented minority students. Students who grow up in low-income families indeed tend to have below-average economic outcomes as adults. That gap in economic outcomes could translate to a gap in loan repayment rates.
However, research by Raj Chetty and colleagues shows that the gap between the adult earnings of students from low-income and high-income families shrinks dramatically for students who attend the same institution. This suggests that choice of institution, and likely choice of program as well, equalizes adult earnings to a considerable degree. Risk-sharing will skew enrollment of both low-income and high-income students towards institutions that deliver a solid economic footing for their graduates. Institutions that serve their students poorly will see enrollment shrink, but that is more a bullet dodged than an opportunity denied.
Risk-sharing will skew enrollment of both low-income and high-income students towards institutions that deliver a solid economic footing for their graduates.
Moreover, the Pell Grant bonus will supply extra funding to institutions that enroll low- and middle-income students in high-return programs. This creates an additional financial incentive for schools to enroll more low-income students, provided those schools deliver strong outcomes.
Will risk-sharing result in a major tuition increase?
Some worry that risk-sharing liabilities will induce institutions to raise tuition to cover the new expenditure. However, economic modeling suggests that risk-sharing would result in a negligible tuition increase, and this would be concentrated at schools with the worst outcomes. Moreover, the assumptions in that analysis assume no dynamic response on the part of schools to avoid penalties by improving ROI. Allowing for dynamic behavior means schools would find it advantageous to lower tuition, not increase it, to reduce penalties.
For many schools, tuition hikes will be self-defeating. The amount that colleges must pay to compensate the government for losses on loans rises considerably as repayment rates fall. The upshot is that if colleges hike tuition to cover risk-sharing liabilities, they will also increase students’ loan burdens, reduce repayment rates, and increase risk-sharing assessments. Higher tuition is therefore unlikely to improve the school’s net financial position, especially after repayment rates drop below negative 10 percent.
Nevertheless, if policymakers are still concerned about tuition increases, they could consider an overall cap on lending through the currently-unlimited Grad PLUS and Parent PLUS loan programs so institutions are constrained in raising tuition.
Is it fair to charge risk-sharing payments during a recession?
Some determinants of graduates’ earnings are out of institutions’ control — namely, the macroeconomic cycle. In some years, earnings may be lower than usual due to a recession. However, the risk-sharing framework observes loan repayment over a five-year period, which should moderate the impact of the economic cycle on cohort repayment rates.
Institutions might also consider exploring ways to shelter their graduates’ earnings from macroeconomic risk to boost the reliability of loan repayment. One promising model is degree insurance, which tops-up students’ earnings if they are below an agreed-upon benchmark. Schools purchase these insurance policies on behalf of their students to offer their graduates financial security.
How should risk-sharing handle low-performing but socially valuable programs?
Some argue that fields of study which typically have below-average earnings, such as education, nonetheless provide a valuable service to society. Risk-sharing could negatively impact these programs. However, exempting these programs from accountability is not an appropriate remedy. An education school may still charge exorbitant prices or provide low-quality training; it should not get to flout the rules simply because it offers a particular sort of degree.
Socially-valuable programs should be subject to risk-sharing, but other policy changes could be in order. The best option is to increase wages so that the social value of an occupation aligns with what people in that occupation are paid. For instance, Congress might consider reallocating Public Service Loan Forgiveness subsidies into a direct tax credit for teachers and other socially valuable careers. Higher earnings will translate to higher loan repayment rates and smaller risk-sharing liabilities for education schools.
Another option is to reduce the cost of training for socially valuable occupations. Currently, the federal student loan program effectively subsidizes state governments that impose heavy degree requirements on licensed occupations such as teachers. But past a certain point, there is little evidence that more education is beneficial; research has repeatedly shown that master’s degrees, for instance, do not make teachers more effective. Risk-sharing would force state governments to question whether excessive education requirements for public-service professions are justified.
Conclusion
For too long, colleges and universities have enjoyed unfettered access to hundreds of billions of dollars worth of federal student aid. That funding has come with few strings to ensure that schools deliver solid economic returns for their graduates. The accountability system outlined in this white paper would change that.
First, the system requires colleges to compensate taxpayers for a portion of unpaid student loans. This encourages schools to improve outcomes or lower prices to avoid penalties and maintain unfettered access to federal loans. The plan also requires schools to put up a financial guarantee against risk-sharing liabilities to ensure that schools have immediate skin in the game for their students’ loan outcomes. Finally, the system rewards institutions that deliver strong outcomes at a low price point by routing extra Pell Grant funding to high-ROI programs.
This three-part accountability system creates a market-based system of incentives for institutions to improve student outcomes instead of leaving taxpayers to bail out borrowers who cannot repay. The system will save the government an estimated $6 billion per year, while ensuring that more students can access high-ROI education.
Policymakers cannot fix the federal student loan program without addressing the underlying reason many borrowers cannot pay back their loans: education that does not justify its cost. By aligning price and value in higher education, this accountability system will ensure that the federal student aid system works for both students and taxpayers.
