In January, the Biden administration unveiled a proposal to slash monthly payments for federal student loan borrowers who enroll in income-driven repayment (IDR) plans. Previously at OppBlog, I highlighted some of the problems with the plan, including its exorbitant cost, its inflationary effect on future borrowing and college tuition, and the perverse new subsidies it will introduce for degree programs with little return on investment.
In testimony before the House Education and Workforce Committee last Thursday, economist Adam Looney of the University of Utah highlighted another unintended consequence of the IDR expansion: it will render useless one of the few outcomes-based accountability policies currently in place for federally funded institutions of higher education.
The cohort default rate
Currently, colleges and universities can lose access to federal funding if a certain percentage of former students defaults on their loans. (For student loans, a payer is in default after 360 days without making a scheduled monthly payment.) If the cohort default rate (CDR) exceeds 30 percent for three consecutive years—or 40 percent for one year—the school may lose eligibility for federal aid.
In practice, the CDR fails to hold most low-quality schools accountable. The default rate threshold is set too high, meaning many schools with poor loan repayment outcomes face no sanctions under the rule. Schools have also found ways to manipulate the CDR. As a result, the number of institutions subject to a loss of aid eligibility is usually in the single digits, out of nearly 5,000 schools using federal loans.
The CDR does have one redeeming feature, though. Some schools with poor economic outcomes voluntarily choose not to participate in the federal student loan program because they fear they would have a CDR that triggers a loss of aid eligibility. This could jeopardize these schools’ access to other federal aid programs, such as Pell Grants. In 2014, for instance, a number of community colleges did not participate in the federal loan program. This segment of schools enrolled nearly one million students, nine percent of the sector’s total.
This deterrent effect has stopped many low-quality colleges from pushing federal loans on students who may never be able to repay them. Under the Biden administration’s proposed changes to IDR, however, this deterrent could disappear.
The IDR reforms will set a $0 monthly payment for borrowers who earn less than 225 percent of the federal poverty line, or $32,805 for a single person in 2023. Under such a system, around 40 percent of students who attended two-year colleges will never make a single payment on their loans.
Scheduling a $0 monthly payment for an enormous chunk of borrowers will help many avoid defaulting on their loans. This will have some benefits: default can come with severe penalties, which I have argued are overly punitive. But the drop in default rates does not signal any change in the underlying value of the education provided. Even if they do not technically default, many borrowers will nonetheless fail to repay their debts because of excessive tuition and a low return on investment on their degrees.
The drop in expected default rates means that many low-quality institutions will soon find it advantageous to participate in the federal loan program, since there will be little fear of losing aid eligibility due to a high CDR. As Looney puts it, the changes will “allow low-quality, high-risk programs currently threatened with sanctions under existing rules to enroll high-risk borrowers.”
IDR reform makes stronger accountability more urgent
Even before the Biden administration proposed overhauling IDR, the cohort default rate was an outdated metric. The administration’s changes, though, will neuter one of CDR’s last useful features: it has kept many of the lowest-quality institutions out of the federal student loan program entirely.
The federal student aid system needs a stronger accountability framework adapted for the challenges of today. In a white paper for FREOPP, I propose requiring colleges to compensate taxpayers when former students do not repay their loans. This would discourage schools from offering programs where economic returns do not justify the cost of tuition, as students who pursue these programs are unlikely to pay back their debts.
These compensation requirements would be triggered regardless of whether the reason for nonpayment is loan default or simply a $0 scheduled payment under IDR. Both reasons signal that the economic value of the student’s education did not justify its cost, and both result in a net loss to taxpayers. It follows that colleges should be held accountable in both cases.
As Looney concludes, “the fundamental problems that caused the student loan crisis—useless degree programs and exorbitant costs—can’t be solved by encouraging students to take out bad loans with promises to forgive them later.” The only solution is to discourage federally funded colleges from offering these programs in the first place.