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One Free Market Reform Could Solve the Student Loan Crisis

Prices for higher education have skyrocketed, students are falling deeper into debt, and the government may offer debt forgiveness, costing universities millions. A surprising free market idea could solve the college bubble, allowing future students a way out of crippling debt, and universities more independence from the government.

From a young age, Americans have been taught that college education is like an investment—the university accepts your money or offers you a loan to train you, and if you succeed based on your education, it asks that you contribute to the university long after you graduate (and sometimes, not that long afterward). While colleges gain most of their money through tuition, many colleges have large endowments, where rich former students or other benefactors grant money for specific purposes and keep the college running.

Why shouldn’t colleges take this idea to the next level? Instead of requiring steep tuition fees for each semester, the school could craft a long-term agreement with the student—the student pays minimal tuition, so long as the college can collect a certain percentage of his or her earnings later in life.

Peter Ainsworth, Managing Director of EM Applications, recently proposed this idea in a paper for the Institute of Economic Affairs in London—“Universities Challenged: Funding Higher Education Through a Free-Market ‘Graduate Tax.’”

A “free-market graduate tax” may sound self-contradictory, and is likely a misnomer, since universities – not government – will levy this “tax.” As Ainsworth explains, “universities would offer contracts to their students, who would agree to pay to the university they attended a given share of their earnings in return for their degree course.”

“Essentially, the university would be taking an equity interest in the graduate premium earned by the student,” making the investment of education a true financial venture.

This long-term plan would not be mandatory—students could still choose to pay the full fees up-front. But this investment would allow more flexibility—and less governmental involvement—in higher education.

“This reform would incentivize colleges to provide an education that actually prepares students for the workforce.”

Rather than government offering special loans for college, universities would offer a long-term contract.

In the current system, government funding and loan programs provide an incentive for more people to attend college and get themselves into debt. Many of these graduates cannot find jobs requiring the skills they learned in college, so they end up working a job not much better than they could have had before college. They may use their degrees later in life, but the immediate return on investment is low, and all they have to show for four years of hard work is a mountain of debt.

In other words, the student pays the full price of his or her education, and the university gets paid whether its teaching benefits the student’s job prospects or not. The university does not necessarily have an incentive to help the student succeed.

In the new system, by contrast, graduates would still owe the universities a percentage of their income. But if graduates did not find better paying jobs due to their degrees, the university would also lose profit. If the university helps them achieve greater financial success, it would automatically reap the benefits.

In short, this “free-market graduate tax” would incentivize colleges to give students an education that would actually prepare them for the workforce. It would be in their interest to teach students how to create value and make more money.

Furthermore, it may improve the fairness of college admissions. Rather than accepting students to fill certain quotas, or admitting the dean’s son due to nepotism, colleges would have the incentive to accept only the students who can stand on their merits and achieve success later in life.

This reform would also spur stricter academic standards, as colleges would have a vested interest in actually teaching their students how to succeed.

The new focus on success may even encourage colleges to address certain social laxities, like rampant alcoholism on campus. If students waste their time in college by overindulging in sex, drugs, and rock-and-roll, they would not only be costing themselves, but the university as well.

Convincing government to pull out of any economic sector will prove both difficult and drawn out, but new ideas like Ainsworth’s “tax” would push colleges one step further toward economic independence. And with economic independence comes more intellectual freedom, paving the way for a true marketplace of ideas.

  • Wesley Gant

    Might work for some colleges, but I wouldn’t support as a standard model. This plan assumes that it is the responsibility of colleges to ensure their students are financially successful. There are two problems here: 1) a college cannot control the personal and professional decisions individuals make in their lives, and should not be accountable for them. 2) With the exception of certain professional degrees, college isn’t supposed to be about a career—it’s about getting a well-round education to be a better citizen, friend, relative, etc. This idea further narrows the role of higher education, in a similar way that No Child Left Behind tied K-12 curricula to tests. The article suggests the plan would put pressure on colleges to deliver real value, but it only identifies one specific type of value, which doesn’t account for many things colleges provide that do no show up on paychecks. Students and parents must take responsibility for their own investment by evaluating the benefits and risks of different colleges in relation to their own needs.

    • imoorenewton

      A possibility is to put this idea to work for two year and 4 year technical degrees and find a more suitable incentive and investment concept for more liberal arts style degrees. Loans are a real problem for artisans and public servants like teachers.(my dad was a special ed and elementary major)

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