Conventional Fixed-Schedule Versus Income Contingent Repayment Obligations: Is there a Best Loan Scheme?

As more countries are planning to inaugurate or enlarge student loan schemes, much of the debate is over the question of the optimal form of the repayment obligation: specifically, whether it should be according to a fixed schedule of payments or a percentage or earnings or income. This paper argues that the current fascination with income contingency is frequently based on a set of supposed advantages, some of which are mistakenly attributed to income contingency either out of misunderstanding on the part of advocates or for political purposes of overcoming resistance to the underlying notion not of loans, per se, but of cost-sharing itself. The paper goes on to advocate a hybrid loan scheme, which can offer the best of both forms of repayment obligation. Student loan schemes have become widespread throughout the world; Shen and Ziderman (2007) reported some 75 in 2007. By the term loan scheme, we mean a program, in most cases involving governmental sponsorship, that covers some portion of instructional or student maintenance costs or both and that results in a repayment obligation, whether this obligation is actually called a loan or by some euphemism (such as a graduate tax) and whether the obligation is to a fixed schedule of payments or is expressed as some percentage of the borrower’s future income or earnings. Some schemes are small: severely rationed by limited loan capital, or sponsored only by a single institution or consortium of institutions (generally private), or focused only on low-risk borrowers such as advanced professional students or borrowers who can produce multiple, credit-worthy co-signatories. A few schemes, including several in Africa, are financially fragile and have little record as yet of repayment recovery. The largest schemes, found in advanced industrialized countries like the United States, Canada, Japan, Korea, Australia, The Netherlands, Sweden, Norway, Germany, and the constituent countries of the United kingdom, are generally available, meaning that all or nearly all students are entitled to a loan of some sort. However, while the importance of student loans seems bound to increase, and while student loan schemes are on the political table in many more countries, any scheme that is generally available requires considerable governmental involvement—which may include any or all of the setting of rates and terms, the provision of subsidies, the provision of capital, the assumption of risk, and/or the actual origination and servicing of the loans—and student loan schemes may therefore be resisted both by ministers of finance, who may fear their financial cost D. Bruce Johnstone is SUNY Distinguished Service Professor of Higher and Comparative Education Emeritus at the State University of New York at Buffalo and Director of the International Comparative Higher Education Finance and Accessibility Project. This article appears in a special issue, Financial Support to Students through Student Loans, edited by Adrian Ziderman in Higher Education in Europe,Vol. 34, No. 2, 2009. An earlier version was presented at an International Conference: Increasing Accessibility to Higher Education: International Examples of Student Loans held at the University of Lisbon, June 2, 2008. to the treasuries, as well as by students, who may fear the encroachment of tuition fees (Johnstone, 2004a, 2005, 2006a). Student loan schemes are also complex, widely misunderstood, sometimes misrepresented, and frequently contested—although the political and ideological opposition tends to be aimed less at the notion of student borrowing itself than it is at a presumption that a governmental loan scheme is a kind of camel’s nose into the tent of cost-sharing (Johnstone 2004a). This paper examines the complexity of the forms and aims of student loans and in so doing attempts to shed a bit of light on what has come to be a question that is, perhaps ironically, important less in its own right, but because it is so widely misunderstood and sometimes misrepresented that it has become, at least arguably, a distraction to good policy analysis (Johnstone 2004b). This is the question: is there a best student loan scheme as between a conventional fixed schedule and an income contingent repayment obligation (the latter being an increasingly popular form in which the repayment obligation is expressed as a percentage of income or earnings)? To anticipate our conclusion, we prefer neither—or rather both: that is, our preference is for what we have called the hybrid version that contains elements of both fixed schedule and income contingent repayment obligations (Johnstone, 2004b, 2004c, 2005). This is not an opposition to income contingency per se, and especially not to the essence of this form of obligation, which is to provide better protection against repayment burdens becoming unmanageable. However, we are opposed to the overselling of income contingency—in particular, the attribution of certain favorable student loan features to income contingency when they can as easily be attached to loans of a more conventional variety, including the above-mentioned hybrid version of a repayment obligation. We object even more to the promotion of the income contingent form of repayment obligation in countries where incomes are too frequently not recorded, easily hidden, paid under the table, or easily shifted among family members. And even in the industrialized countries of the EU or the OECD, where a financially viable income contingent loans scheme is more technically feasible, there are problems (or at least complexities) of income definition, income shifting, emigration, cross border employment, access to capital markets, and threats to voluntary income reporting and tax collection that have not always been sufficiently addressed by its proponents. Forms of Student Loan Repayment Options Let us first identify with greater precision what differentiates the student loan forms under question: that is, the conventional or fixed schedule, the income contingent, and the so-called hybrid form of repayment obligation. 1 Income contingent loans are attractive in developing countries because there is usually violent opposition to the imposition of cost-sharing, and an income contingent repayment obligation—especially one that never passes through the hands of the students but is merely left as a sort of income surtax—is thought to be more politically acceptable. However, the incidence of repayments in such schemes falls mainly on civil servants and employees of larger corporations, whose incomes are known and whose repayments can be verified. Thus, just as large amounts of income in the larger economy are unreported and generally undiscoverable for the purpose of income taxation, so large amounts of loan repayments are likely also to go undiscovered and unpaid, jeopardizing both the financial viability and the fairness of the loan scheme (Johnstone, 2004c).