The Pearson Centre for Progressive Policy

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INCOME-CONTINGENT LOANS for Grads

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November 7, 2014

INCOME-CONTINGENT LOANS for Grads

By Anthony Carricato

The cost of post-secondary education in Canada today means that many students need to borrow large amounts of money in order to pay for tuition and other schooling-related costs.  While most borrowers repay their loans fully and on-time, the current repayment provisions under the Canada Student Loans Program are often too onerous on recent graduates, resulting in a not-so trivial amount of borrowers falling into default, or spending a significant amount of their after tax earnings on monthly payments towards their investment in post-secondary education.

According to Employment and Skills Development Canada, the current financial aid system in Canada, in particular its fixed schedule repayment obligations, are causing 13.8% of borrowers to default on their student loans (ESDC, 2013).  Furthermore, 1 in 4 student borrowers are enrolled in the federal government’s Repayment Assistance Plan, a program designed to assist borrowers who are having difficulty repaying their loan.  In 2011-2012, the repayment assistance program cost the Government of Canada $109.8M, which is an increase of $21M from the previous year (ESDC, 2013). Considering that post-secondary education tuition fees are rising faster than inflation, the number of student borrowers in Canada in need of assistance in repaying their loan is not likely to decrease.  It is also becoming very expensive for the federal government to sustain.  This suggests an opportunity for policy action.

One of the ways that the federal and provincial governments could help reduce the financial burden placed on students who pursue post-secondary education in the post schooling years is by reforming the repayment provisions contained in Canada’s national student loans program so they are linked to borrowers income.   This type of financing scheme, known in the literature as income-contingent loans, safeguards graduates from default in periods of low income and requires borrowers to bear the costs of post-secondary education when they can afford them.

The primary goal of Canada’s student aid programs should be to ensure that the financial costs of pursuing post-secondary education do not pose an undue barrier to entry.  Additionally, programs should aim to limit or reduce unnecessary financial hardship during the schooling period as well after it.  At the same time, the overall system of financing post-secondary education should provide an appropriate balance between the burdens imposed on the general public in their role as taxpayers and on the students while also reflecting the relative benefits derived by these two groups.

The idea of a financial aid system where students could borrow from the government in order to finance post-secondary education costs and repay that loan as a percentage of future earnings was first introduced by Milton Friedman in his 1955 essay entitled “The Role of Government in Education.” Friedman saw this as a way to phase out automatic public subsidy of universities and colleges and allow a greater role for student choice in allocating public subsidy.  To a certain extent, an income-contingent repayment scheme for student borrowers is “a compelling solution to theoretically separate, but practically entangled, goals: injecting more financial resources into universities without raising government expenditures, and facilitating student access by providing a fair method of loan repayment” (Bosma, 2007, pg. 14).  Of course, the level of government support for post-secondary education is a separable issue from the structuring of student loans; the income-contingent repayment concept could be implemented without reducing—or even with increasing—the public subsidy provided to post-secondary education institutions.

The defining feature of an income-contingent repayment scheme is that the collection of the debt depends on the borrower’s future levels of income.  Therefore, repayment is based on capacity to pay, rather than the amount borrowed and time. An income-contingent type of repayment approach would primarily provide better protection against unmanageable repayment burdens and make it impossible for student borrowers to default on their loans and therefore would ensure that the government is recouping most of the money it lends to students.  An additional benefit of this type of scheme is that it would facilitate consumption smoothing – a term used to describe an optimal balance of individual spending and saving, while a student borrower is in repayment.

Since most students who pursue a post-secondary education will eventually earn higher earnings than those who do not, further subsidizing post-secondary education by offering income-contingent loans could have a potential regressive impact on income distribution.  The concern is that individuals who do not pursue a post-secondary education are further subsidizing the cost of post-secondary education for those who do, since taxpayers generally pay for the subsidies inherent in income-contingent loans.  To be clear, income-contingent loans do not reduce the cost of post-secondary education; they simply prolong the repayment period in order to make the loan more manageable. The length of the repayment period will vary depending on an individual’s earnings after they leave school.  Therefore, income-contingent loans offer borrowers who earn lower incomes after gradation the ability to repay their loan more with higher earnings in the high earning stages of the lifecycle.

Several countries, including Australia, New Zealand, the United Kingdom, and to some extent the United States, have adopted a form of income-contingent lending for student borrowers.   Evidence coming out of those countries indicates that the real benefit of income-contingent loan schemes is that they have provided graduates with the ability to consume more in the early year after graduation, when typically, young people require financial liquidity to establish themselves, get married, buy a house, etc.  Since some graduates will experience significant variance of income while in repayment, it is critical that they be able to continue to consume in periods of unexpected low income without defaulting on their student loan.

Provincial and federal financial aid schemes have become essential in providing students with financial liquidity in order to pay for schooling related expenses.  That said, the manageability of current repayment provisions that accompany these loans in Canada are creating financial hardship for too many graduates in the post-schooling years, when incomes are lower and young people are establishing themselves in the workplace.   Moderate reforms to the Canada Student Loans Program should be considered in order to improve the manageability of repayment provisions resulting in less defaults and increased consumption smoothing.  Delivering loan relief through income-contingent loans based on a long period of post-graduation earnings experience by the borrower is both fairer and better targeted than the types of loan relief embodied in current student loan programs.

 

Additional thought provoking content on this subject:

Barr, N. A. (2012). The Higher Education White Paper: The Good, the Bad, the Unspeakable – and the Next White Paper. Social Policy & Administration, 46(5), 483-508.

Barr, N. (2001). Income-contingent student loans: An idea whose time has come. In Nick Barr (Ed.), (pp. 583-600) Elgar Reference Collection. International Library of Critical Writings in Economics, vol. 132; Cheltenham, U.K. and Northampton, Mass; Elgar; distributed by American International Distribution Corporation, Williston, Vt. Retrieved from http://search.ebscohost.com.proxy.lib.sfu.ca/login.aspx?direct=true&db=ecn&AN=0729979&site=ehost-live

Berlinger, Edina. (2009). An Efficient Student Loan System: Case Study of Hungary. Higher Education in Europe, 34(2), pp. 257-267.

Bosma, P. (2007). ICLRPs: An overview. Toronto, ON, CAN: Ontario Undergraduate Student Alliance.

Chapman, B. (2005). Income Contingent Loans for Higher Education: International Reform. The Australian National University Center for Economic Policy Research Discussion Paper NO. 491. Canberra, ACT.

Government of Canada. (2013). Annual Report: Canada Student Loans Program 2011-2012. Employment and Social Development Canada, Ottawa, Ontario. Retrieved from: http://www.hrsdc.gc.ca/eng/jobs/student/reports/annual/cslp_2012.shtml

Government of Canada. (2013). Statistical Review: Canada Student Loans Program 2011-2012. Employment and Social Development Canada, Ottawa, Ontario. Retrieved from: http://www.hrsdc.gc.ca/eng/jobs/student/reports/statistics/cslp_2012.shtml

Guillemette, Y. (2006). The Case for Income-Contingent Repayment of Student Loans. Toronto, ON, Canada: C.D. Howe Institute.

Johnstone, D. B. (2009). Conventional Fixed-Schedule Versus Income-Contingent Repayment Obligations: Is There A “Best” Loan Scheme? Higher Education in Europe, 34(2), 189-199. Retrieved from: http://search.ebscohost.com.proxy.lib.sfu.ca/login.aspx?direct=true&db=eric&AN=EJ857277&site=ehost-live;http://www.informaworld.com/openurl?genre=article&id=doi:10.1080/03797720902867377

Schwartz, S. (2006). Recent Changes to Student Loan and Tuition-Setting Policies in Post-secondary Education: Comparing Australia, New Zealand and the United Kingdom.  Skills Research Initiative, Working Paper 2006 C-13. Ottawa: Human Resources and Social Development Canada, Government of Canada. Retrieved from: http://www.ic.gc.ca/eic/site/eas-aes.nsf/eng/ra02008.ntml

Anthony Carricato, M.A. is a graduate of the School of Public Policy, Simon Fraser University. For many years he worked on Parliament Hill for the Speaker of the House of Commons and has recently completed a contract as a senior policy analyst with the Association of Universities and Colleges of Canada. He can be reach at anthony.carricato@gmail.com

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