Is There a More Flexible Way for Students to Invest in Themselves?

By Joel Grey

State Treasurer Ted Wheeler has proposed a new program intended to help Oregon students go to college in spite of the quickly ballooning cost of tuition. Under the proposed “Oregon Opportunity Initiative,” the state of Oregon could borrow money by selling general obligation bonds and then invest the proceeds. Students could receive grants or other subsidies from the earnings on this investment each year, while taxpayers would be responsible for paying back the bonds. The state must use all discretionary spending necessary to pay back bondholders with interest over thirty years. Bonds issued for this purpose likely would reduce the opportunity to bond for other critical needs of the state such as roads and bridges.

This proposal is potentially a costly mistake for Oregon and fails to prevent the inflated cost of education from growing even faster.

Even with the increased cost of college, higher education can still be a good investment for individual students. People with bachelor’s degrees likely will see their incomes increase by more than the cost of attendance over their careers. Because of this, it is unwise to eliminate part of the cost to the student by having taxpayers help fund their education. Students should pay for their own education, even if they are not paying at the time they are enrolled.

If the cost of college to the student is reduced, it creates a third-party payer problem: Because they are not directly affected by cost increases, students will worry less about the price of college, allowing it to inflate more over time. Conversely, if students are expected to pay for their education, they are more cautious about expenses and debt.

Even traditional loans have a third-party payer problem because costs are externalized to the future. Students have to pay eventually, but they don’t necessarily fully consider this because it is a long-term issue. While traditional loans lead to problematic student debt, there are other ways of financing education that don’t lead to third-party payer problems.

One viable solution to student debt was proposed almost sixty years ago by Milton Friedman: human capital contracts. A private person or institution, such as a bank or investment firm, pays for a student’s education. In exchange, the student pays a fixed percentage of income over a certain period of time. Human capital contracts would be more flexible than traditional loans. As a percentage of income rather than a fixed dollar amount, they would be less likely to be financially burdensome to the borrower and would thereby lower the rate of default.

Human capital contracts are also more flexible for the lender. Current federal loans treat all students equally in rates and borrowing limits. Private institutions could offer lower or higher rates based on an individual student’s career path or academic performance, allowing certain students to receive lower rates while riskier students are given higher rates.

Human capital contracts are likely to benefit lower-income students the most. It is very unlikely that those students could afford to pay for college up front, but they would have the same earning potential as anyone else in their field upon graduating. Human capital contracts would allow them to use these future earnings to make college attainable in the present.

While human capital contracts are also a third-party payer system, the private nature of the funding gives lenders an incentive to control their costs. They will need to ensure that students can pay back what they borrowed. The federal government doesn’t have the same incentive with its student loans because it doesn’t need to earn a profit.

Human capital contracts are not a silver bullet; nothing is. For example, they likely wouldn’t be useful for students who only intend to work part time or to become stay-at-home parents because lenders couldn’t recoup their investments. However, human capital contracts are a better choice overall for students and Oregonians when compared with the taxpayer-funded Oregon Opportunity Initiative. They would eliminate many problems of current loans, provide an incentive to view education as an investment, and control costs. All of this would help manage the expense of college long-term while still allowing students from any income bracket to attend college.

Joel Grey is a research associate at Cascade Policy Institute, Oregon’s free market public policy research organization.

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