There's a big caution sign appearing in front of the government's generous program to let borrowers cap their monthly student loan payments to a percentage of their earnings. Use of so-called income-driven plans could cost $22 billion more than the government expected, raising concerns about the sustainability of a cornerstone of the Obama administration's education policy.
Although Politico, which first reported the expense, called it a shortfall, budget analysts say it's not a deficit but rather a revised estimate of costs. The expense was tucked into a footnote of Obama's 2016 budget proposal. It is largely based on the increased use of Pay As You Earn, a repayment plan for federal loans that caps borrower's monthly bill to 10 percent of their income and forgives the debt after 20 years of payment.
It has taken a while for borrowers to warm up to these plans, mainly because so few have known of their existence. But now that more people are on board, the costs are starting to rise, according to revised estimates from federal budget analysts.
Obama wants all struggling borrowers with government loans to be eligible for the plan, not just the ones who took out debt after 2007. But if that $21.8 billion is the harbinger of things to come, it could become difficult to justify the program to taxpayers.
Still, with national student debt approaching $1.3 trillion and many young graduates struggling to find jobs that pay enough to cover their monthly payments, the government's flexible repayment plans are critical.
People who miss out are more likely to default on their student debt, which comes with serious consequences. Defaulting on student debt can severely damage a person’s credit rating, making it much harder to buy a car or a house or get a credit card.
Income-driven plans are designed to prevent borrowers from defaulting on their loans, a problem faced by about 20 percent of people repaying college debt.
As the White House has redoubled its efforts to get the word out, there has been a significant increase in the number of people signing up for the plans. The percentage of people enrolled in the programs at the end of September increased 64 percent from the same time a year earlier, according to the Education Department.
"Pay-As-You-Earn will ultimately serve taxpayers well by helping students avoid default and ensuring students are able to responsibly manage their debt as they repay their student loans," said an official in the White House budget office. "It will strengthen the economy by encouraging more young people to go to college and by lifting the burden of unaffordable debt off of recent graduates."
To be clear, $22 billion represents about 2 percent of the federal student loan program. That number is based on current and future cash flow over the life of the loan, so it's liable to change if borrowers repay faster.
What's more, there is no escaping repaying federal loans. Uncle Sam will find you, take your tax refund or garnish your wages, even your social security check—meaning there is limited risk of the government losing money. And as graduates repay their loans over the next decade, the government is projected to yield $135 billion, according to the Congressional Budget Office. That's just an estimate, but you get the point.
The president's budget does propose reforms to the repayment plan, including limiting the participation of graduate students and removing the cap as people earn more, that is project to save $14 billion over 10 years.
Still, the increased cost of the repayment plans raises questions about where government subsidies for higher education should be applied.
For years, federal policy largely focused on helping needy students through Pell Grants and education tax credits on the front end. But as more student began leaving college with crushing amounts of debt, the government started to look at initiatives to help people on the back end through income-driven plans.
It's hard to argue against the need for Pell or income-driven plans in face of sky-high tuition and stagnant wages, but a growing number of policy wonks are questioning whether tax credits and deductions are the best use of scarce resources, said Terry Hartle, senior vice president at the American Council on Education, which represents colleges and universities.
"Trading tax breaks for increased Pell or better loan repayment options is intellectually appealing, but it is politically and practically impossible to pull off," he said.
Under federal budget rules you can't take money from tax code savings and put it in an entitlement or discretionary program. And then there is the practical problem. People like, and have come to rely on, their tax breaks—as we saw with the push back against the president's proposal to end a tax benefit of 529 plans.