Income Contingent Loans and Higher Education Financing: Theory and Practice

Abstract

The expansion of higher education is both necessary and desirable. But, as the opening section of this chapter explains, higher education is costly and faces competing imperatives for public spending. The second part of the chapter explains the market failures faced by lending to finance investment in human capital and compares two approaches to addressing them: a graduate tax, where graduates repay a fraction of their earnings for life, or till retirement (i.e., equity finance), and income contingent loans, where repayments stop once the graduate has repaid his or her loan; and concludes by discussing designs which combine the two approaches. The third section discusses the ill-effects of blanket interest subsidies and provides brief assessments of reforms of higher education finance in the UK, New Zealand and Hungary, all of which have income contingent systems. A concluding section briefly outlines unanswered theoretical questions about the design of student loans.