Paying It Forward to Pay for College

The public and private sector should both jump at the chance to finance higher education.

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President Obama today unveiled new proposals to help reduce college debt – mostly ideas previously broached to encourage universities to keep their costs down. There is a more novel idea out there, however, that's been gaining an impressive amount of momentum in recent weeks: "Pay It Forward" plans, in which students get free college tuition upfront and then pay for their educations over several decades as a percentage of their incomes. But even this is merely the camel's nose in terms of what's possible in changing human capital investment in this country.

It's not like there aren't ways to make colleges more cost-effective: sharing courses and facilities, utilizing campus buildings year-round, tying funding to performance measures, increasing commercialization of scientific breakthroughs. But the main driver of tuition rates is not needless costs, it's the amount that's underwritten by taxpayers: The less public funding for higher ed, the higher the tuition charged at a state's campuses. In recent decades, public budgets have come under increasing pressure; state spending goes to three main functions – caring for seniors, locking up criminals and educating the young. It's not hard to figure what gets cut first.

Hence, the explosion of interest in Pay It Forward. But forestalling payment until one's earning years isn't exactly a new idea: It's called a loan. Conditioning the payment on income is the great attraction of "Pay It Forward" plans – but this isn't exactly new, either. Milton Friedman proposed the idea 70 years ago. The federal government has offered "income-contingent" loan options for nearly 20 years, basically the same concept as today's "Pay It Forward" (except that high-earners don't pay more).

[See a collection of political cartoons on the economy.]

The Pay It Forward plan recently enacted in Oregon, which has jump-started the push for similar laws elsewhere, calls for allowing students to pay 3 percent of their annual incomes for 20 years after graduation. Unfortunately, this covers tuition, but not the other college-going expenses (room, board, books, and fees) that cost students even more. One way or another, students will wind up paying (which means, most likely, borrowing and then paying) for these expenses, too. Fifteen years ago, I put together a similar plan for the governor of another state – we calculated that the state would need 5 percent of the average future earner's income to cover these costs and make the program sustainable in the long-run.

The real virtue of such a plan is the two-way commitment it embodies: We as a society invest in our people and their future. We as individuals recognize that if society helps us to get where we eventually get, then we actually owe something back for that success – more, the more successful we are. Elite private universities already started moving in this direction in recent years. Some version of Pay It Forward is probably the future.

What's most interesting about it, though, is the larger potential it holds for human capital investment generally. The vast bulk of Americans will not obtain college degrees – but the majority will still need significant, and costly, post-secondary education or training. There's no reason that such non-baccalaureate investments cannot be financed the same way: Receive the investment first, pay for it later, base the payment on how successfully the investment produces the desired result – a higher income – kinda like, hmm, investing. Individuals could (as Friedman foresaw) finance their self-improvement through a share-of-future-profits investing model. At this point, it should be clear that we're talking about moving beyond simply public financing – students and workers could enter into such a percentage-of-earnings arrangement with private backers, too.

[VOTE: Should Oregon Public Universities Adopt a 'Pay It Forward' Tuition Model?]

And that's been done, as well: David Bowie. Yep, Bowie wanted some cash 16 years ago and sold the rights to his future royalties. David Bowie may be sui generis in lots of ways, but he's not unique in being able to capitalize a future income stream. In theory, anyone can.

In fact, existing student loan programs, which to some extent represent a similar gamble on the student's future ability to pay, don't have much trouble attracting financial institutions: A college education is a good financial bet. Of course, they have one other thing going for them: a government guarantee.

And there's the ultimate answer to what government generally – and the federal government specifically – can do about college, and other human investment. Select individuals, like David Bowie, may be able to go out and attract financing for their futures, but in the absence of a broad market it will be hard for most. The government, however, can make such a market, both by providing guarantees to entice private lenders and, more crucially, by boot-strapping a secondary market that allows the repackaging of individual loans and risks into safer securities. Say what you want about subsequent mismanagement of mortgage markets at Fannie and Freddie, but there would not be broad home ownership today – not at the levels we know as the "American Dream" – without the secondary mortgage market that the federal government essentially invented and underwrote.

[See a collection of political cartoons on the budget and deficit.]

There is perhaps nothing more important to our nation's future than higher levels of investment in human capital. Since that is, ultimately, a "public good," economics tells us there won't be optimal investment without government spending. But because the nature of public goods is to generate "externalities" – economic benefits that the investor doesn't capture – the public, which pays the taxes but doesn't see the return revenue stream – gets restive. So here comes a way to capture the externality: having beneficiaries of the investment pay it back according to its success. If governments start doing that, it's the kind of program that doesn't become susceptible to future attack as "welfare," because it's actually profitable – meaning that, eventually, the private sector will start doing it, too, making money, and easing the government out of the "business" (if – a bigger "if" than most people think – it can provide the service better and cheaper).

From the broadest perspective, then, the lesson here is that new solutions to our challenges still exist, but they will require using private-sector mechanisms for many things we think of today as public-sector responsibilities, meanwhile recognizing the need for an active public sector to make much of this private, profitable activity possible. Now, that could be educational.

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