Phenomenal World

Phenomenal World

October 10th, 2018

Who should pay for college?

—   Dan Herbst

Who should pay for college?

—   Dan Herbst


“Free college” has become a popular talking point over the past couple years, but despite a spate of glossy policy proposals that are branded otherwise, we all know that, just as with lunch, there’s no such thing as a free higher education. Even if enrollees paid zero tuition, somebody has to pay for the classrooms, professors, and administrators needed to provide a college education. The real question is: who should pay for college?

For many free college proponents, the answer is “the taxpayer.” They believe government should pay for the cost of providing higher education, much as it does middle school or high school. Many European countries have adopted this model or something like it, subsidizing university to the point where students face little or no cost of attendance.

But unlike middle and high school, less than half of Americans aged 25 to 64 hold a four-year college degree. And while society at-large draws some benefit from a more educated populace, most of the value of a college education goes directly to the student; the returns to a degree in medicine or engineering are largely realized through higher salaries for doctors and engineers. Should we really ask grocers and coal miners to pay for their tuition?

The simple fact is that free college is a regressive policy; it disproportionally helps those who are more advantaged, transferring billions of dollars to relatively affluent families—money which could be spent to alleviate poverty or improve primary and secondary education.

Nonetheless, a system of free college holds several appealing features. First, college subsidies might encourage enrollment among disadvantaged students. A number of studies find that financial aid programs can increase enrollment, especially those applied universally to a population of students.1 And while most of financial benefits of a universal “free college for all” would accrue to students who would have attended college anyway, a more targeted approach is unlikely to yield the same enrollment benefits. Means-tested aid is already a feature of the current higher education system but applying for this aid is complex and burdensome, preventing many from enrolling.2 Unfortunately, a “free college for some” would simply replace financial barriers with administrative ones.

Second, free college moves the financial burden of college away from parents. Even though college attendees enjoy higher incomes over their lifetime, typically the tuition bill comes due when they are still reliant on their parents’ incomes. This “tuition bomb” not only harms middle-class families, but it impedes intergenerational mobility by linking college access to parental wealth. An ideal system of higher education financing would remove this link to equalize access across individuals of different backgrounds.

Finally, free college provides some insurance against earnings risk. While college attendees enjoy higher lifetime incomes on average, the financial returns to college vary considerably from person to person. Even as millions of graduates land lucrative careers, some face circumstances which prevent them from reaching their full earnings potential—not every college student becomes a doctor or engineer. The sunk cost of college tuition or accumulated student debt can loom large for these individuals. Moreover, the risk of these unforeseen events might discourage would-be college students from ever attending, even if it is a financially sound decision.

An ideal system of financing higher education would incorporate all of these features. But so far, we’ve constructed a patchwork of targeted aid and subsidized loans that does not offer them. Financial aid directs funds to the most needy, but lacks the simplicity necessary to overcome barriers to enrollment. Student loans allow borrowers to push college costs into the future, but lead many low-earning graduates to financial ruin. With these shortcomings of the current system in plain view, calls for radical change like free tuition should come as no surprise.

But are these our only options? Are there really no alternatives other than costly, regressive government transfers? What if there were a way to eliminate financial barriers to entry, remove the cost burden for parents of prospective college students, and lighten debt loads for struggling student borrowers, without leaning on the taxpayer?

In fact, the solution may lie in a more creative approach to higher education financing. Instead of asking students and their families to pay huge sums of money at the point of enrollment, we should recoup the cost of tuition from students when they can actually afford it—years later, once they’ve realized the income gains associated with a college degree. This means linking college attendance costs to post-graduate income, so college grads pay what they can afford, when they can afford it. The student loan system isn’t built this way. Student loans are typically paid over just ten years, and payments do not adjust to borrowers’ post-graduate incomes.

We could even construct a variant on the “free college” model that operates in exactly this way—make college “free” at the point of entry, but then levy a special income tax on graduates when they enter the workforce. As graduates gain experience and earn higher wages, they pay an increasing share of college costs. If higher wages never materialize, they can pay a little less. If they land a great job with a high salary, they can pay a little more.3 On average, borrowers would “pay their own way” in the long run. But borrowers would also be insured against the earnings risk, so college dropouts wouldn’t have to forego groceries to try and pay down their debt.4

As it turns out, we’re already taking steps in this direction. In several countries, student borrowers can use publicly offered non-traditional, earnings-based repayment options to finance their college education. In the U.S., the federal government provides this option through Income Driven Repayment (IDR) plans, whereby student loan payments are pegged to a fixed portion of post-graduate income. Borrowers make these payments until their balances are zero or reach some forgiveness period. This structure adapts the repayment schedule to fit varied or volatile career paths, allowing young borrowers to avoid financial distress. Indeed, recent evidence suggests IDR improves borrower welfare, and enrollment in IDR plans has tripled in the past
few years. 5

As governments increasingly offer income-based methods of higher education financing, similar options have begun to proliferate in the private sector. Income-Share Agreements (or ISAs) allow private entities to help college students with tuition in exchange for a share of their future income. These agreements are increasingly offered to undergraduates professional students at various universities as a low-risk alternative to parental support or private loans. In contrast to IDR, ISAs are not loans at all—an ISA enrollee does not carry a debt balance or pay any interest, but instead pledges some portion of her earnings at pre-specified dates in the future. By framing contracts this way, ISAs offer a similar “pay-as-you-earn” structure to federal IDR programs without the psychological cost of carrying debt.

Neither IDR nor ISAs provide a silver bullet to the financial struggles of college enrollees, and both have flaws. IDR programs require active opt-in, and payments only adjust after borrowers complete burdensome proof-of-income procedures. ISAs can be helpful to selected population but are unlikely to provide a large-scale solution without government support. We could improve upon these ideas by developing a universal, auto-enrolled, “graduate tax” system with automatic payroll deduction like the one described above.

Unfortunately, however, rather than focus on ways to improve upon promising innovations like IDR or ISAs, public discussion is dominated by calls for the government to make college free or forgive all student debt. Proposals like these are undoubtedly made with the best of intentions, and with goals in mind that we can all share. But if we want a fair, accessible, and effective system of higher education, we should focus more on reforming how tuition is paid rather than who pays for it. Investing in a college education provides a student with benefits that last a lifetime. By enacting policies that align the costs of college with these benefits, we can better equip students to make this investment themselves without asking the taxpayer to shoulder the burden for them.

Title Who should pay for college?
Authors Dan Herbst
Date 2018-10-10
Collection Higher Education Finance
Filed Under
References & Links
  1. For a review, see Deming and Dynarski (2008).
  2. See Bettinger et al. (2009)
  3. The idea of a “graduate tax” to pay for higher education dates back to Friedman [1962].
  4. A growing body of empirical evidence points to the financial struggles associated with student loan repayment. Roughly one million borrowers default on their student loans, and millions more struggle to buy homes (Mezza et al. [2016]), accumulate wealth (Bleemer et al. [2017]), or choose their preferred career (Rothstein and Rouse [2011]).
  5. See Herbst (2018)
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