The Obama administration’s primary proposal to increase progressivity of the program is to “[e]liminat[e] the standard payment cap under PAYE so that high-income, high-balance borrowers pay an equitable share of their earnings as their income rises.”296In other words, borrowers would pay 10% of discretion- ary income all the way up the income distribution and would not default back to the ten-year loan payment once income is high enough. That appears reasonable on its face, and would address the odd shape of the payment schedule shown in Figure 1. The recently adopted REPAYE plan incorporates this change.297
The problem is that, under the current rules, the result would be to accelerate the rate at which a high-income borrower pays off a loan, rather than increase the total amount paid. If a PAYE borrower pays only until the total payments equal principal and accrued interest, then increasing the monthly payments just means paying off the debt more rapidly. That could also mean less revenue for the government in present-value terms, if it is charging a spread above its borrowing cost. This could in turn lead to less subsidization by high-income graduates and more from general revenues—not necessarily ideal. This is in contrast to Australia’s HELP program, in which accelerating payments de- creasesthe subsidy to high-income graduates because the subsidy is largely due to a low interest rate.298This is a major oversight in the new REPAYE program.
295. See supratext accompanying notes 143–50.
296. U.S. DEP’T OFEDUC.,supranote 135;see alsoU.S. DEP’T OFEDUC.,supranote 165, at R-13.
The other proposals focus more on cost management and limiting incentives for schools to increase tuition. The New America Foundation made a similar proposal.SeeJASONDELISLE& ALEXHOLT, NEW
AM. FOUND., SAFETYNET ORWINDFALL?: EXAMININGCHANGES TOINCOME-BASEDREPAYMENT FORFEDERAL
STUDENTLOANS 14 (2012), available at https://static.newamerica.org/attachments/2332-safety-net-or-
windfall/NAF_Income_Based_Repayment.18c8a688f03c4c628b6063755ff5dbaa.pdf. 297. SeeREPAYE Rules,supranote 134, at 67,213–14.
Offsetting that cost would be a decrease in the amount of forgiveness after twenty years. Suppose someone had low income for the first ten years and thus accrued a substantial unpaid balance. If that person had a high income for the next ten years, and thus paid what would have been the original ten-year loan payment, it is possible that there would still be an unpaid balance after ten years. If instead, the payments during the last ten years were a function of income, and thus higher than the standard ten-year loan payment, there would be less to forgive at the end of twenty years. It is difficult to know the distributional impact of these two effects together given our limited experience, but it is at least not certain that removing the annual payment cap would lead to more progressivity in all cases.
Therefore, to ensure that changes like removing the annual payment cap or even introducing graduated rates, such as in Australia’s HELP program, increase progressivity and redistribution, thelifetimecap would also have to be lifted or removed so that high-income graduates would pay more than the present value of their tuition. For example, the government could require all borrowers to pay a percentage of discretionary income at flat or graduated rates for at least fifteen years, even if a traditional loan would have been paid off sooner.299This would be similar to the design of Yale’s TPO and Oregon’s PIF programs.
But this would introduce a number of problems. First, and most obvious, is the political risk to the program if high-income graduates start to see it as unfair. This is part of what led to the demise of Yale’s program. Second, as already noted, there is value in keeping the payments tied to the benefit of the good itself.300If the payments become decoupled from benefit and become merely a function of income, then they truly become income taxes, with all the distor- tions and politics that go along with that. Third, lifting the lifetime cap could remove what little market check there is on tuitions. Right now, the nominal tuition amount still affects the total amount paid. Even if payments were only a function of income, students would still have a reason to care about the school’s list price. If the lifetime cap were changed or removed, however, that final reason would disappear, leaving schools either free to raise tuition as much as they would like or, alternatively, subject to stiffer government price regulation.
A more immediate and practical way to increase progressivity would be to raise the statutory student loan interest rate. In 2013, the interest rate on unsubsidized federal loans was 6.8%, and the rate for subsidized loans had recently changed from 3.4% to 6.8%. These high rates were controversial, given high debt loads and tuitions. The charge was that the government was profiting
299. This would also require either disallowing prepayment or adding a prepayment penalty. Currently, full prepayment is allowed without penalty. 34 C.F.R. § 685.209(a)(3)(ii) (2015). The prepayment would ideally be targeted to the present value of the expected spread the government was to earn on future interest. But a rough measure, such as the 150% prepayment allowed under the Yale TPO plan, might be appropriate.See supranote 273 and accompanying text.
from the need of students who could not afford to pay up front.301 Congress
responded by passing the Bipartisan Student Loan Certainty Act of 2013,302 which fixed the interest rate for undergraduate loans at the ten-year Treasury note rate plus 2.05% (capped at 8.25%), and the rate for graduate loans at the ten-year Treasury note rate plus 3.6% (capped at 9.5%).303For 2015–2016, that
meant rates of 4.29% and 5.84% for undergraduate and graduate Direct Loans, respectively (and 6.84% for Graduate PLUS loans).304
This change was misguided, in my view. If income-driven repayment is widely adopted, then the only people who would actually pay a high rate like 6.8% are those with relatively high income; all others pay just 10% of discretion- ary income with limited interest accrual and capitalization, and possible forgive- ness, and so should be largely indifferent to the statutory interest rate. Thus, lowering the statutory rate for undergraduates may actually have made the overall PAYE system less progressive and put a greater burden on general revenues. Increasing the rate would put more of the overall cost of the program on high-income graduates without the risk of entirely decoupling the payments from the underlying tuition.305