Shifting Interest Won’t Lower College Costs

Issue Brief

Congress appears poised to approve a new plan to increase federal higher education spending. But the policy’s financial planning looks a lot like the stereotypical undergrad’s.

The plan would cut the interest rate on student loans in half over a period of five years — from 6.8 percent to 3.4 percent — effectively shifting the balance of the cost from those students to taxpayers. The plan would cost taxpayers nearly $6 billion, according to the Congressional Budget Office.

That’s because it wouldn’t really cut student loan interest rates; only the portion paid by graduates. The federal government guarantees student loan companies, like Sallie Mae and Nelnet, a certain rate of return; if market interest rates spike, the taxpayers cover the difference. Taxpayers also continue to assume much of the risk on defaulted loans.

The proposal would offset its costs by reducing government payments (and guarantees) to loan providers. Providers could simply turn around and pass along those costs in the form of reduced benefits to borrowers. Explains Peter Warren, Vice President of the Education Finance Council, “Loan providers – particularly those that are nonprofits – currently use the interest margin they make on loans to give borrowers rate reductions, fee waivers, loan forgiveness and other benefits. So what the plan gives to borrowers with one hand, it takes back with the other.”

Critics counter that the plan won’t really expand access to college. As Congressman Jeff Flake asserted last week, “It is unclear whether such a burden on taxpayers would help make college more affordable.”

It might do exactly the opposite — make higher education more expensive. As economist Richard Vedder has explained in Congressional testimony, “When the federal government increases subsidized student loans, gives a Pell Grant or grants a tuition tax credit, it increases the number of students wishing to attend college at any given tuition fee.”

The evidence certainly supports Dr. Vedder’s analysis. College costs have been rapidly outpacing inflation for decades. According to the College Board, the cost of attending a private college has soared by 52 percent, adjusted for inflation, since the 1991-92 academic year; public colleges have increased costs by a whopping 86 percent in the same time span. Tuition and fees for the current academic year at private, four-year institutions reached $22,218, up $1,238 or 5.9 percent from last year. Prices at public, four-year institutions went up 6.3 percent, or $344, to $5836.

Since 2001, direct student aid has exploded from $9.6 billion to $48 billion. During the same period, the number of students receiving such aid soared by nearly one-third, from 7.6 million to 10.1 million.

If the $6 billion cost estimate for the plan is correct, it will cost nearly two-thirds as much as all direct federal student aid just six years ago.

What’s more, this spending won’t reduce financial pressure on current students. That’s because those with subsidized loans don’t pay the interest while they’re in school. As Congressman Howard P. “Buck” McKeon observed recently, the proposal “provides benefits to those who are no longer even students.” College grads don’t start paying back their loans, along with the interest, until six months after they finish, and that’s only if they don’t enroll in graduate school.

So the College Student Relief Act is really the College Graduate Relief Act — the expansion of a regressive wealth transfer program benefiting a demographic group the College Board estimates will earn $1 million more in their lifetimes than the hardworking American taxpayers without college degrees who will have to pay for it.

There is a better way. It’s time for policymakers to take a hard look at the reasons for escalating college costs — including rapidly rising federal student aid — and pass policies that really can make college more affordable, not expand entitlements that ultimately lead to higher tuition costs.