How to Fix Federal Student Aid with Income Share Agreements

The battle between Republicans and Democrats over how to make college more affordable is simple: Democrats say it will never be affordable in a private market, and so taxpayers must foot the bill.  Republicans say it will never be affordable until government subsidies stop distorting the market, and so government should get out of college financing entirely. 

Neither side is likely to achieve total victory.  In the meantime, government subsidies will continue to drive up college costs but leave gaps for low- and middle-income students.  This broken system will continue to be underwritten by taxpayers without a college degree, along with students and parents, who carry $1.7 trillion in debt and counting.

Today, colleges may charge whatever they wish for the education they provide, the government provides the capital, and colleges bear little meaningful risk if students do not repay.  This cannot continue.  If students borrow responsibly and earn a good living after they graduate, their alma mater should benefit too. However, if they make too little to repay what they borrowed, the college, not taxpayers, should bear the burden.

To begin to address these challenges, Congress could make income share agreements (ISAs) provided by each student’s college available to students. Like all ISAs, students with a risk-sharing income share agreement (rISAs) would have their education paid for upfront in exchange for repaying an affordable percentage of their income for a predetermined number of months.  This proposal is detailed in a new report for the American Enterprise Institute.

What makes an rISA different is that a college's success is tied to its students' success.  While the Treasury would provide upfront capital, the student’s college would be responsible for repaying principal and interest to the federal government. Anything collected through the rISA from the student above the amount borrowed would be the college’s to keep, but any shortcoming would be the college’s responsibility to reconcile.

Another positive side effect is rISAs would drive students toward programs with strong labor market value and away from programs in which students are less successful after graduation. Under the plan, colleges could set different repayment terms (i.e., percentage of income owed and the repayment term length) for students depending on their major. For example, students in a top business program might receive more scholarships or even attract outside investment capital and receive favorable repayment terms. On the other hand, students enrolled in a midrange art history program with poor future earning potential might see a less attractive deal.  Colleges would be strictly prohibited, however, from setting rISA terms based on family income or other factors, such as race, that are protected under the Fair Lending Act.

A risk is that rISAs would draw students away from creative endeavors or careers such as teaching that often pay less. This can be addressed, however, by redeploying need-based scholarships and other aid toward students in these high-value, lower-paying occupations and by reassessing decades of credential inflation, where more education is required for the same job at the same pay. Colleges could also make scholarships go further by packaging them into the rISA and providing generous terms that expect less than a dollar-for-dollar return.

Because the college can supplement (or offset) federal capital with its own capital, courses and other services that would not otherwise be eligible for federal aid could be paid for with nonfederal funds and packaged into the same rISA. An English major could enroll in a coding boot camp, or a student in a general studies associate degree program could earn a welding certificate. Each student would enjoy a better educational experience but still make a single, affordable payment tied to their income.

While rISAs would be federally capitalized, they would not be federally run. Colleges would be free to choose servicers and other partners, which they cannot do with federal loans. They would be incentivized to work with those that are best at providing excellent customer service to their alumni.

Forcing Democrats and Republicans to back off demands for either full federal payment of college costs or none at all may be tricky, but Congress has endorsed loan programs that share risk with colleges before.  Both parties should be able to support financing arrangements that ensure students can afford their monthly payments, open doors to new, career-aligned educational offerings, and empower colleges to design arrangements that work for their students. These changes alone could break the partisan gridlock and force colleges to focus on affordability and student success.