Should the US Reform the Student Loan System?

Anyone who has read my previous columns about paying for college knows that I’m a student debt hawk. Student loans in their current form are dangerous: it’s too easy to borrow massive quantities; they can almost never be discharged in bankruptcy; and students and parents rarely understand what kind of quicksand they’re getting into.

At the same time, a “buy now, pay later” system makes sense. We have all sorts of public subsidies for college tuition, including the federal student loan program, because having an educated population benefits everyone.

But many of the benefits of a college education—such as higher earnings and the opportunity to spend four years having inebriated pseudo-intellectual conversations with your peers—accrue to the student. So students and their families should pay something, and providing a traditional four-year degree is not cheap.

Perhaps in the future, online degrees from something like Khan Academy or iTunes U will be as sought after as Harvard diplomas. In the meantime, college costs real money—and even if online degrees become standard, there’s always the opportunity cost.

If you’re watching lectures and taking tests, that’s time away from earning a paycheck. I’m optimistic about the potential of electronic courses, but they’re not going to cram a four-year degree into one year — except for rare hotshots.

While I’m sympathetic to the idea that college should be as free as public high school, the idea is politically untenable and, let’s be honest, would lead to a lot of aimless hacky-sacking.

But there is one reform well within reach that would make financial life easier and more predictable for college graduates: perhaps we should make our student loan system more Australian.

From a Land Down Under

The Australian university financing system is complicated and includes controls on tuition rates, but the key provision that the US could easily adopt is to make student loan repayment part of the tax code.

Here’s how it works. Once you graduate from college in Australia and get a job, you begin repaying your student loan via paycheck withholding, exactly the same way you pay your income taxes.

The repayment scheme is highly progressive: if you make less than about $45,000, you owe nothing on your student loans. Make between $45,000 and $50,000 and you’ll pay 4% of your income. Make over $91,000 and you’ll pay 8%.

The repayment amount is tied to your income, not the amount of your loans. You can pay extra on your loans at any time, and you receive a bonus for doing so. Once your loans are repaid, the paycheck deduction automatically stops and your paycheck gets fatter.

This is similar to the Income-Based Repayment (IBR) plan available to federal student loan borrowers in the US. The key differences are:

• IBR is available only when you have a financial hardship. The Australian system is for everyone.
• IBR still relies on voluntary repayment.

The last point is key. We may not like it, but most of us faithfully pay our taxes on time because the IRS makes it easy. If we had to send them a check every month or every April, the rate of tax evasion and underpayment would jump enormously.

Self-employed people are responsible for withholding their own taxes and paying them quarterly, and tax problems are extremely common among freelancers. W-2 employees hardly notice that they’re paying taxes. (I once asked my brother how much tax he paid, and he said, “Zero.” He meant that’s how much he owed in April.)

Yes, you can and should set up automatic payments for your student loans, but it’s still not the same. You’ll get into trouble when you change jobs or change banks.

This is one instance where it’s to your benefit to have the government’s hooks in you: since your student loan payments are going to the government, and you’re punished harshly for failing to pay, why don’t they make it easy?

We’re not talking about a scary government takeover. The federal government already owns the vast majority of student loans and already collects taxes via the IRS. Putting them together would make the repayment system more sane, fair, and effective.

One more thing

True, not all student loan payments are owed to Uncle Sam. But private student loans account for less than 10% of student loan originations, and they’re among the worst kind of debt: high interest, ineligible for IBR, and still not dischargeable in bankruptcy.

The government can and should nationalize private loans and bring them under the federal system or, at the very least, make them eligible for bankruptcy. Private loans rarely make the difference between being able to attend college or not, because the neediest students are eligible for the most grant and scholarship aid, plus subsidized federal loans.

What I’m talking about here is a small reform. It won’t solve the problems of students taking on too much student debt or attending colleges they can’t afford.

But it would meaningfully improve the lives of many people facing down student loans, at a minimal cost to the government, and it’s not a new idea: it’s been tested in the sun-baked laboratory called Australia.

Matthew Amster-Burton is a personal finance columnist at Mint.com. Find him on Twitter @Mint_Mamster.