As Congress debates the issue of student-loan interest rates, several proposals have been put forward to extend current interest rates on subsidized Stafford loans or to reduce rates even further. However, if the goal is to protect students from unmanageable debt loads, income-based repayment is a far better tool than interest subsidies for both students and taxpayers, and should be the focus of reform efforts.
That is why I introduced the Earnings Contingent Education Loans (ExCEL) Act, which would ensure that all students are protected by a streamlined and fiscally sustainable income-based repayment (IBR) program. Such an alternative for all federal student loans could accomplish the goals of our current array of repayment options without their complexity. It would eliminate much of the paperwork and bureaucracy that make the current IBR option difficult for students to use, and it would replace the overly generous forgiveness provided by current IBR plans with protections for students that are also fiscally sustainable for taxpayers.
Additionally, the program I'm proposing would move to a market-based interest rate and discontinue the in-school interest subsidy provided for subsidized Stafford-loan recipients. In contrast to interest subsidies, which are based on a student's family income before she enrolls, IBR ensures that all students are protected when they truly need it—during periods of low income after leaving college. This more directly helps those truly in need.
The idea of income-contingent loan repayment was developed decades ago by the conservative economist Milton Friedman and the liberal economist James Tobin. Independently, they concluded that repaying student loans through fixed payments doesn't make sense because graduates tend to earn less when they first leave college and to make more over time. Therefore, payment amounts should be an affordable percentage of their income, with protections for those who struggle with low income.
Since then the concept has gained bipartisan support, including from the Reagan, Clinton, and Obama administrations. In addition, numerous recent reports on reforming the federal financial-aid system agree that income-based repayment is right for borrowers.
But the income-based repayment option now available through the federal student-loan system fails to live up to its potential. It is far too complicated and was added to a system that is already mind-numbing in its complexity. An often overlooked fact is that while many people believe the high default rate (over 13 percent) on federal student loans is the result of overborrowing or high interest rates, a significant number of defaults involve manageable amounts of debt.
The reality is that although the federal student-loan system includes numerous protections to help borrowers avoid default, it has become such a patchwork that many students simply fail to navigate its bureaucracy and fall needlessly into default.
For instance, to take advantage of the current income-based-repayment option, a borrower must submit documentation of income so her servicer can set a proper payment level. If the borrower's income changes in the middle of the year, including through unemployment, the borrower must contact her servicer and repeat the process to change the payment amount. That can be a burden, particularly for someone who just lost a job.
In my proposal, payment amounts respond in real time to changes in income without all the paperwork, and borrowers can have their employers deduct their payments as a simple percentage of their paychecks. A borrower who loses his job need take no action to notify a servicer or the government. Much like taxes, withholding means you pay your obligation as you earn every dollar, and your obligation ceases automatically during periods when you have no income.
The point of using withholding is not to save borrowers the trouble of writing a check. It's to eliminate much of the administrative complexity that makes current IBR cumbersome for borrowers to use. Similar reforms, put in place years ago in Australia, New Zealand, and Britain, have been shown to work.
Another flaw in the current IBR plan is that it is simply not fiscally sustainable. It offers borrowers forgiveness after 20 years. As researchers at the New America Foundation have shown, that can be a windfall for many students, particularly high-debt graduate students who borrowed without limit under the federal loan program. We cannot have a system in which taxpayers absorb ever-higher levels of unpaid debt. Proposals to expand forgiveness even further are moving in the wrong direction.
Under the ExCEL Act, low-income graduates would have strong protections—such as a cap on the total amount of interest that can be accrued on a loan—but all borrowers would have a responsibility to repay what they borrow. Accordingly, the proposal would discontinue the Public Service Loan Forgiveness Program, which provides unlimited forgiveness to anyone who works for 10 years in the public sector, a benefit that is neither fair nor sustainable.
A properly structured income-based repayment system would offer far better protections to all borrowers than interest-rate subsidies do, and would be far less expensive. We should put one in place to benefit students and taxpayers alike.