Income Share Agreements and the Importance of Political Optics
Posted By Derek Johnson on November 12, 2015 at 1:26 pm
As the gravity of the student loan crisis and its impact on a generation of graduates has slowly come to bear on public consciousness, more outside-the-box ideas from think tanks and academics are being considered as alternatives. These range from government savings accounts established early in a student’s life and tuition-free college to “unbundled” a la carte education. What’s more, one idea, called income sharing agreements (ISAs), is creating much debate among its proponents and detractors.
The idea is not new, per se: similar policies were proposed as early as the 1950’s by conservative economist Milton Freedman. However, ISAs received an update and boost in recent months by policy analysts at powerhouse think tanks like The American Enterprise Institute and The Brookings Institute, who have been pushing the agreements as an alternative to federal student loans.
In a nutshell, ISAs shift loans from the federal government to the private sector, subsidizing a student’s higher education degree in exchange for a percentage of their future earnings. There are other substantive differences between ISAs and the current federal student aid system we use to finance college today (see here for a more complete breakdown), but the most controversial aspect of the debate centers around whether it is ethical for private companies to claim ownership over a percentage of a student’s future earnings, with some comparing the arrangement to indentured servitude. Inside Higher Ed’s Matt Reed lays out some of the potential pitfalls:
“At a really basic level, [ISA advocates] err in treating [. . .] institutions as if they were consumer retail. They are not. They are self-conscious efforts to achieve a broad social good. By social good, I mean something that goes beyond the payoff to the student. Community colleges are called that because they exist to serve the community. That means helping high school dropouts with adult literacy classes. (I don’t imagine investors lining up for that one.) It means teaching ESL to people whose first languages aren’t English. (The “indentured servitude” parallel would get really disturbing there, assuming any investors at all.) It means offering second chances to students any rational investor would have long since abandoned.
Those aren’t design flaws. They’re features.”
Not surprisingly, proponents of income share agreements push back on the indentured servitude line, arguing that ISAs actually give students more freedom in determining career paths, not less. A trio of authors from the American Enterprise Institute provide a rebuttal to this charge:
“…a traditional, fixed-payment student loan, particularly one that is extremely difficult to discharge in bankruptcy, more severely restricts a student’s freedom than an ISA. Graduates who are struggling to repay their loans could face years or decades of hardship and limited job choices, whereas graduates with ISAs can make whatever choices they want, including taking entrepreneurial risks that may pay off in the future but that might not have been possible in the presence of student loan debt.”
In general, this exchange highlights what is probably the biggest obstacle to increased use of ISAs: the policy suffers from terrible optics.
By nature, policy wonks tend to focus on the steak, not the sizzle: they value what they perceive as the substance of a policy more than how to market it. It’s what separates policy experts from political scientists and pundits. But political optics (how a policy is packaged and marketed to the public) can at times supersede substance, and the fact of the matter is that any arrangement that involves struggling college students forking over a percentage of their profits to a corporation is going to be a very hard sell.
While proponents argue that, in an ideal world, these agreements would be offered by a mix of non-profits and for-profit and private sector institutions, logic dictates that it will be organizations which already have the existing capital and lending infrastructure in place that will wind up providing most of the investments. When smaller institutions, like New York-based human capital investment firm Pave, have attempted to offer ISAs to students, they eventually folded the program due to struggles collecting enough funding to serve more than a few dozen at a time. For the most part, only current lenders, financial institutions and large corporations can implement ISAs on a large enough scale to justify their initial upfront investment.
That’s a very big problem, because corporations, lenders and financial institutions are incredibly unpopular, according to public opinion. According to Gallup, the public’s confidence in banks (i.e. the world’s major lenders) has plummeted in the past decade. Since 2005, the number of Americans who expressed “some”, “very little” or “no” confidence in big banks has gone from approximately 50 percent of the public to over 70 percent this year. Over that time, those expressing “very little” or “no” confidence rose from 12 percent to 26 percent. The change isn’t as pronounced with big business, but that could be because the public already had such little faith in corporations that there weren’t too many people left to convince.
Needless to say, a policy that gives these institutions a bigger role in financing higher education – and a cut of students’ future earnings – isn’t likely to go over well with the public, regardless of the specifics.
On top of general trust issues, proponents of Income Share Agreements argue that they are capable of serving students of all income backgrounds. However, this idea was challenged by a recent American Institute of Research study which examined the current ISA market and found that “the widespread use of ISAs to support the educational aspirations of low-income undergraduates in particular may run headlong into the priorities of those offering this type of financing.” The study found that historically,.the main beneficiaries of educational ISAs have been “high ability students attending prestigious institutions in lucrative fields of study.”
Alexander Holt of The New America Foundation and Kevin James of The American Enterprise Institute penned a joint response critical of the AIR study and taking issue with its methodology. They argue that ISAs are fundamentally different from the sort of lending conducted by banks and financial institutions, and that the handful of companies used for the study do not meet their definition of proper ISA lenders.
However, the fact that there are virtually no organizations that do meet this definition should give the authors pause. While in some respects, the ISA market is relatively new, the basic idea is not (remember – Milton Freidman was writing about it when Dwight Eisenhower was in office). Either the market doesn’t believe their ideal lending model is profitable in the long run, or those that have tried decided to adapt the model to current lending processes. The authors claim that using these companies to draw inferences about the effects of ISAs is “nonsense”, but it is any more realistic to use a model that has almost no real-world examples to point to?
Either way, the burden is on supporters to demonstrate that such a system would be protected from predatory lenders and information asymmetry. Since ISAs provide different terms depending on factors like field of study, the process will inevitably wind up pitting a single individual in negotiations against an army of corporate lawyers. It’s difficult to see how Joe and Jane College would be able to extract fair or favorable terms in anything other than a tightly regulated environment.
And that’s the rub. Our current federally financed student aid system is rife with inefficiency and bloat, leaving millions of students buried in crippling debt. But the political climate, post-Great Recession, still indicates that the public would rather direct their complaints to the U.S. Department of Education than the higher education equivalent of Goldman Sachs.