Against Our Interest: We Don't Need a New Student-Loan Burden

COMMENTARY Budget and Spending

Against Our Interest: We Don't Need a New Student-Loan Burden

Jan 17, 2007 3 min read

Senior Fellow, Manhattan Institute

Within the next few days, as part of their "first 100 hours" legislative blitz, congressional Democrats have promised to "make college more accessible" by halving the 6.8-percent interest rate on subsidized student loans. While parents and students certainly understand the strains of college costs, this policy is unaffordable, unnecessary, and even illogical.

Despite persistent claims of cuts, student financial aid spending since 2001 has surged by a staggering 400 percent - from $9.6 billion to $48 billion, according to the Office of Management and Budget. This makes the Office of Federal Student Aid the fastest-growing agency in the entire federal government.

Much of this increase has come from an unanticipated surge in the number of college graduates consolidating their student loans (which will lead to large federal subsidies to banks). However, the student aid budget is projected to level off at approximately $25 billion - nearly triple the 2001 level.

Congress's focus on interest rates is curious because current rates are quite low by historical standards. This school year, the variable student-loan interest rate - which was set to jump to over 7 percent - was replaced with a fixed 6.8-percent rate that is lower than in all but six of the past 42 years.

Furthermore, the basic idea that cutting student-loan interest rates will "make college more accessible" makes no sense. College affordability depends on family income and financial aid availability, relative to tuition and fees. The interest rate doesn't matter until after graduation when repayment begins. For a low-income student facing a $4,000 federal borrowing cap and an $8,000 tuition bill, lowering the post-graduation interest rate from 6.8 percent to 3.4 percent does nothing to help afford tuition today.

The more relevant variables are grant and loan limits relative to tuition and fees. True, the maximum Pell Grant of $4,050 is just $300 over the 2001 cap. However, the 2005 Deficit Reduction Act created SMART Grants of up to $4,000 annually for students majoring in math, science, engineering, or a foreign language critical to U.S. security. This effectively doubles the Pell Grant for many students.

Today's students can also borrow more. That same Deficit Reduction Act increased subsidized student loan borrowing caps for freshman and sophomores from $2,625 and $3,500, respectively, to $3,500 and $4,500. Graduate student loan limits were increased from $10,000 to $12,000 annually.

Overall, the total amount available for grants and loans has more than doubled since 2001, from $66 billion to $136 billion - or, excluding consolidation loans, from $52 billion to $78 billion. During this period, the number of students receiving aid increased from 7.6 million to 10.1 million, and the number of annual loans and grants provided to those students leaped from 15.4 million to 24.7 million. Clearly, students are already provided with ever-increasing resources to pay their tuition and fees.

Yet these unending student aid increases haven't made college more affordable. The average college tuition, adjusted for inflation, has leaped 86 percent for public colleges and 52 percent for private colleges since the 1991-92 school year.

Paradoxically, many economists now believe that student-aid hikes actually contribute to tuition increases. Colleges, like businesses, charge as much as their customers are able to pay. So when student aid increases, colleges raise tuition accordingly to capture the additional aid. It becomes a vicious circle, with students caught in the middle.

So if reducing interest rates won't make college more accessible or affordable, what will it do? Subsidize future college graduates repaying their student loans.

Before we add "college graduates" to the list of groups needing government handouts, consider that today's typical college graduate enters the workforce with a student-loan debt of $17,500. While this sounds large, it represents a monthly payment of only $114 ($102 when counting the related tax deduction) after conversion into a consolidation loan. Halving the interest rate would shave just $36 off the monthly payment.

Given that a college degree raises the average individual's lifetime earnings by over $1 million, $114 per month is clearly an affordable payment on a very profitable educational investment. Perhaps it's not in our best interest to tax society at large to further subsidize the 24 percent with college degrees and higher lifetime earnings.

America faces substantial budgetary challenges: the war on terror and new homeland security costs must be funded, and projections show worsening budget deficits every year. The coming retirement of 77 million baby boomers will send Social Security, Medicare, and Medicaid costs to levels that could require a doubling of all income taxes. In this context, responsible lawmakers should step back and examine whether a new subsidy for college graduates is really a top priority.

Brian Riedl is a Grover M. Hermann Fellow in Federal Budgetary Affairs in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.

First appeared in the NRO