(Earlier today, I had the privilege of testifying in front of the Joint Economic Committee on reforming higher education finance. Below is the text of my oral testimony, and you can find the written testimony here. You can watch the entire hearing, featuring Purdue President Mitch Daniels and former CFPB student loan ombudsman Rohit Chopra, here.)
I’m here today because the federal approach to financing higher education is on an unsustainable path and too often fails to help those who need it most.
While federal aid per-pupil increased 46 percent over the past decade, net prices and out-of-pocket costs at most institutions have never been higher. Simply pouring more money into the system will not solve these problems, and may make them worse.
That’s because the federal student aid system suffers from four design flaws.
First, it essentially empowers colleges to capture as much federal aid as they can. Aid eligibility is based in part on the cost of attendance, which colleges control. In addition, colleges use detailed financial information about their applicants—furnished by the feds—to price discriminate, often substituting federal grant aid for their own institutional resources.
Second, a lack of clear, comparable information on costs and quality makes it difficult for consumers to identify the most valuable options. Systematic data on student outcomes like learning, job placement, and earnings are rare, hindering consumers’ ability to make prudent borrowing decisions. This reduces the market pressure on colleges to compete on price and quality.
Third, there is almost no underwriting in federal student lending. Any high school graduate can borrow to attend any accredited college at almost any prices. Federal loans and grants provide no signal to students about the value of different offerings and allow them to enroll in poorly performing schools.
Fourth, existing policies do not exercise sufficient quality assurance. Federal eligibility criteria are far too generous, meaning few schools ever lose access to grants and loans no matter how poor their outcomes. Continued access to aid props up colleges that would never pass a market test.
In short, the problem is not only that we make so much money available in student aid, but that we make so much money available with very few strings attached.
One potential consequence is the “Bennett Hypothesis”— the notion that increases in federal aid cause increases in tuition.
Existing research on this question is mixed, but most studies find that at least some types of colleges raise prices in response to federal aid. A recent study found that for every dollar in subsidized student loans, colleges raised tuition prices by about 65 cents. It is difficult to identify whether aid causes tuition increases, but it certainly seems to relax the incentive to keep tuition low.
The Bennett hypothesis has helped explain why federal investments have not kept tuition low. But the focus on price increases ignores a more pressing problem—the failure of federal aid to promote higher education quality. Aid policy provides colleges with plenty of incentives to enroll students, but less reason to worry about whether they are successful.
New College Scorecard data suggest that at a majority of colleges, at least half of alumni earn no more than a high school graduate six years after enrolling. Default rates are highest among borrowers with low balances, and even inexpensive institutions like community colleges have low repayment rates.
With these challenges in mind, there are several reforms that would encourage colleges to compete on price and value:
First, capping PLUS loans to parents and graduate students, which allow unlimited borrowing up to the cost of attendance, seems like a straightforward reform to curb tuition inflation. Reforming generous loan forgiveness programs to encourage prudent borrowing is another.
Second, federal policy should empower consumers with better information about costs and student outcomes. The College Scorecard’s new earnings data is a start. But the federal government should expand on this effort to collect and make public program-level outcome data.
Third, policymakers should create two simple accountability mechanisms based on loan repayment rates: a performance floor that would exclude the worst-performing institutions from federal aid programs and a risk-sharing policy that would give institutions above that floor greater skin in the game. If all colleges were held responsible for a percentage of their students’ unpaid loans, they would have incentive to contain their tuition, maximize rates of student success, and reconsider their admissions standards.
Fourth, reforms should create space for private financing that can inject more market discipline into higher education. In theory, private investors could underwrite on the basis of program quality and future earnings, driving students toward valuable opportunities.
Existing private student loans do not appear to be forward-looking in this way. More than 90 percent of new loans feature a co-signer.
An alternative is an Income Share Agreement, under which students obtain funding for school in exchange for a percentage of their after-school income over a set period of time. Because an investor’s return is directly tied to a student’s success, ISA providers have incentive to help students navigate toward valuable opportunities.
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