This April, while hashing out the bill that reconciled differences between the House and Senate versions of health reform, lawmakers tossed in another overhaul as well. They completely remade the student loan industry.
As a result, college students will pay more for their school loans ... unless they go to work for the government.
Of course, that’s not the story told by those who voted for the change, which eliminated the decades-old Federal Family Education Loan Program. In eradicating that program, Congress took private financial institutions out of the student loan business. Instead, all that lending is now done exclusively by your friendly federal Department of Education.
President Obama lauded the change, suggesting that students would save by borrowing direct from the feds. Congressional sponsors claimed the bill would make student loans more affordable because it would allow graduates whose monthly loan payments exceed 10 percent of their monthly income to extend their repayment period by 10 years or more beyond the norm.
Under the new arrangement, borrowers may extend the life of their loan to as long as 20 years. But while the monthly payments may be lower, borrowers will end up paying much more for the loan, thanks to greater interest costs.
Take the example of a married couple making $100,000 per year. The wife, just graduated from college, has $100,000 in student loans outstanding. Under the new law, the couple qualifies for an income-based repayment plan that lets them stretch out their repayment period to 13 years. The longer-term loan lowers their monthly payment by $175, to $975. But over the life of the loan, they will shell out an extra $13,000 in interest.
But there’s a loophole. Our new grad can avoid paying the additional interest simply by going to work for the government.
Here’s how it works. The College Cost Reduction and Access Act of 2007 established a loan forgiveness program for all full-time public-service employees. It provides that, after 10 years of public service, the remaining balance on all student loans issued under the Direct Loan Program (the only program in town, post-Obamacare), is forgiven.
To appreciate what a sweet deal this can be, let’s assume that the wife in our example above works for the government — federal, state or local, it doesn’t matter. The couple still qualifies for income-based repayment, paying only $975 a month. But because she works in the public sector, they are only responsible for making payments for the first 10 years — approximately $117,000 in principal and interest.
Meanwhile, her identical twin sister, in the exact same financial situation but working in the private sector, is responsible for making all 13 years-worth of payments, totaling $151,000.
In this case, the loan forgiveness program boosts the after-tax value of the public job by $34,000. With a huge bonus like that on the horizon, few workers could be tempted to leave their jobs after eight years of service.
In this way the loan forgiveness program turns student loans into golden handcuffs for government workers.
It’s highly unlikely that private employers will be able to pony up a compensation package more attractive than what the public service wife has even without this incredible student loan premium. Recent studies show that government compensation levels are 12- to 40 percent higher than those of the private sector.
In the end, the new student loan program will hit the economy hard. Young people who chose to go into the public sector will find themselves “job locked,” with few opportunities to leave the public sector without suffering a large financial loss.
This will increase labor market rigidity and drive talent away from the private sector, resulting in a slower economic growth. Meanwhile, taxpayers will continue to be hit with ever increasing tabs for government payrolls, employee benefits and student loans.
Given the current recession, lawmakers would do far better to embrace policies that will boost private sector growth — the only engine for real economic growth. They might also pursue policies that — unlike the federal Direct Loan Program — actually reduce the real cost of higher education.
Paul Winfree is a senior policy analyst in The Heritage Foundation’s Center for Data Analysis.
First moved on the McClatchy News Wire service