Reversing the Great Risk Shift: Federally Funded, Income-Linked Student Loans?

In recent, years, the U.S. has undergone what political scientist Jacob Hacker calls “The Great Risk Shift“. Hacker explains this concept succinctly on his website as follows:

For decades, Americans grew both steadily richer and steadily more secure. They received health and retirement benefits and stable jobs from employers. Social Security, Medicare, and other public programs stepped in when employers would or could not. But over the last generation, this public-private framework of security has unraveled, leaving Americans newly exposed to the harshest risks of our turbulent economy: losing a good job, losing health care, losing retirement savings, losing a home—in short, losing a stable financial footing. Increasingly, Americans find themselves on a financial tightrope, without a safety net if they slip. Bankruptcy rates are skyrocketing, and more people don’t have health insurance or secure retirement benefits. Meanwhile, family incomes fluctuate up and down three times as violently today as they did in the early 1970s. At bottom, what my research shows is simple and frightening: Families are now facing up and down swings that rival the most volatile stocks.

To summarize, American institutions have increasingly put the risk on individuals, and off of large corporations or the state. The clearest example of this sort of risk shift might be trends in retirement accounts. In the mid-20th century, in addition to social security, many Americans paid into “defined benefit” pensions. These pensions were guaranteed to provide a certain amount of income upon retirement. In the last few decades, employers have shifted away from these pensions and towards “defined contribution” accounts, where employees are guaranteed nothing except some tax benefits and perhaps matching contributions. In other words, employees, not employers, now bear the risks of stock market fluctuations and the like.* Similarly, health care plans increasingly cover only a fraction of health care costs (e.g. 70%) and thus require people to pay substantial portions of their (highly variable) health care costs, a pretty straightforward example of “risk shift”. One year, you might owe nothing. Another year, you might owe tens of thousands of dollars and be forced into bankruptcy. Having health insurance no longer shields you from as much of the risk of unexpected health care costs as it used to.

These trends are disturbing, but they also present an opportunity or method for rethinking our social institutions. We can ask, how can we shift risks back onto larger institutions more capable of handling them? Hacker has focused a lot of attention on retirement, unemployment and health care costs, which are logical and hugely important places to start. But we can also extend the same logic into other arenas. Think, for example, of student loans.

Student loans are a big topic of conversation, at least among academics, as they are one of the causes and consequences of the rising cost of college. For-profit educational institutions, like the University of Phoenix, feed off of student loans (without necessarily providing much in return), while more traditional universities rely on student loans to help cover their increasing costs.** Student loan debt is difficult if not impossible to get rid of in bankruptcy, and for students who fail to get high paying jobs can present a serious financial burden, especially unsubsidized private loans. One solution to this problem, so far with only limited uptake, are so-called “human capital contracts”. The NYT had a short piece on the topic: Instead of Student Loans, Investing in Futures. The piece discusses a small private company called Lumni which has so far provided financing to about 1900 students in the US and Latin America along these lines:

Sneider’s dream was to attend college so he could become a nurse and serve his community. To do so, he needed $8,500 — a sum that is close to the average annual income in Colombia. … Here’s the deal that Lumni struck with him: In exchange for $8,530 in financing, Sneider agreed to repay 14 percent of his salary for 118 months after he graduated. At that point, regardless of how much he has paid, his obligation terminates.

So instead of agreeing to repay a fixed amount, Sneider agrees to pay a fixed percentage of his income. For Lumni, the loan still rates to be profitable – much like an insurance system, as long as most loan-recipients end up with decent jobs, Lumni has priced the agreements so that it comes out ahead. If there’s a big recession, on the other hand, and many graduates can’t find decent jobs (like, oh.. the past three years) Lumni would lose money but the individuals themselves would still be above water (or at least not worrying about missing a loan payment in addition to everything else). Lumni bears the risk:

What this means is that the students who have the biggest problems benefit the most. And, in effect, those who decide to become investment bankers end up subsidizing the ones who decide to become social workers. Since a good society needs many different roles fulfilled, everyone benefits.

In other words, you run the great risk shift backwards. But here’s the thing, Lumni is a small private company which can only extend loans to a handful of people. And it faces regulatory and enforcement issues – how do you tell how much money someone makes? Etc. On the other hand, the federal government is already deeply enmeshed in the student loan business, and the figuring-out-how-much-you-make-and-taking-part-of-it business (i.e. federal income tax). So why not have the federal government offer such programs? Offer students a deal: we pay your tuition, you agree to pay a higher tax rate when you graduate. If you graduate, and become a social worker and make $30k/year, it costs you very little. If you get a job on Wall St. and rake in the big bucks, you pay a bit more. If there’s a big recession and graduates can’t find jobs, the government takes a hit but the graduates have less to worry about. If there’s a boom, the government makes a bit more than planned. Income-linked student loans (we really need a catchy name) would provide a way for the government to assume more of the risk of student loans, while still expecting to make a small profit (or break even), but in a countercyclical fashion. And because the federal government already has extensive experience and bureaucracy set up for administering loans, and for collecting taxes, it wouldn’t require a giant institutional leap to implement.***

If nothing else, income-linked, federally funded (or not) student loans provide a nice example of a policy that explicitly seeks to reverse the great risk shift.

* Recent UM B-School PhD Adam Cobb is doing interesting work on this history.
** There has been a ton of discussion of these topics all across the media and internet, from the Chronicle of Higher Education to the New York Times. I highly recommend OrgTheory’s discussion of these topics as one entry point.
*** This statement may be more than a little optimistic. No program is ever simple to implement. But at least it’s plausible this one could be relatively feasible.

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2 Comments

  1. Max

     /  June 12, 2011

    The president proposed something similar in his 2010 State of the Union Speech: loan payments capped at 10% a year, with complete forgiveness after 20 years. That proposal is still structured as a loan, not a tax, and I guess it still involves the government absorbing the risk that a student won’t make much after graduation without also getting the upside if a student makes a great deal after graduation. The government could capture most of that upside by charging very high interest rates, with the understanding that most students won’t ever be affected by them.
    That wouldn’t be as elegant as your proposal, but I think that there might be some resistance on the part of some ‘borrowers’ to a student loan not structured along the lines of a traditional loan. I can imagine a lot of people being put off by an obligation that is on its face open ended, at least until there’s a shift in how we think about educational lending, and I don’t expect that shift to take place overnight.