June 22, 2024

A different way to finance higher education: with equity 

Recent campus crises demonstrate that universities are not sufficiently invested in our nation’s students.  

This should come as no surprise, incentive structures being what they are: Universities are no longer nonprofits dedicated to higher learning, but corporations, with presidents like Claudine Gay operating as asset managers and students functioning like customers. These once venerated institutions claim tax-exempt status and operate profitable endowments that rival some small countries, while leaving many of their graduates ill-equipped to enter the job market and saddled with lifelong debt.  

The corporatization of academia is enabled by our massive federal student loan program. With a reliable stream of capital to fund new generations of students, universities conduct themselves with little to no regard for the quality of their product — a ticket to a stable workplace and the tools to succeed there.  

To see real change in academia, we must remove the federal government from the equation.  

As predicted by Milton Freidman in 1955, the private sector won’t buy in to financing education using traditional debt instruments; borrower outcomes are too uncertain, and the loans aren’t secured by physical collateral. Instead of accepting this market failure, the federal government has put an expensive, taxpayer-supported Band-Aid over it: 93.1 percent of the $1.3 trillion student loan debt is held by the government.  

The ideal way to finance higher education is just like any other risky venture: through equity.  

Student loans should resemble contracts in equity, where students finance higher education by selling a stake in their future income. Instead of a fixed principal tied to interest rates, investors’ returns are tied to the professional success of the student,akin to owning shares of a private corporation that produce higher returns based on its success.  

Known as income share agreements (ISAs), the contracts operate like this: Say a student agrees to commit 7 percent of her income for five years after graduation. If the student does well, she will pay full-price tuition with additional returns for the provider. If she does poorly, she may never repay full cost. Cross-subsidization by high earners helps to defray losses from low earners.  

Ideally, the ISA provider is the university itself. University-provided ISAs align the financial incentives of the student and the institution, drastically shifting campus culture and forcing universities to combat tuition inflation and bureaucratic bloat.  

Since 1980, even adjusted for inflation, the cost of tuition and room and board has increased 180 percenteight times faster than wages, practically guaranteeing that earnings won’t make up for the cost of tuition. Tethering university earnings to students’ post-graduate income incentivizes institutions to get lean and deliver a dependable product with an eye toward employability. American academia would necessarily spend less time squabbling over trivial social issues and more time teaching tangible skills. Universities like Northeastern or University of Waterloo that offer co-op programs with nearly guaranteed post-graduate employment might become the norm. 

For those who shudder at the thought of a society entirely composed of engineers and lawyers, income share agreements would still help those pursuing degrees that don’t guarantee lucrative employment. With the right income share agreement model, a savvy investor could fund diverse students within an income share agreement portfolio, using cross-subsidization by high-earners to serve as a safety net for those pursuing liberal arts careers.  

Important too, university-provided ISAs would transfer some risk away from students and taxpayers. Under the current model, many students graduate only to see their loan balance increase due to high interest rates and poor employment outcomes — 40 percent of borrowers are projected to go into default this year. ISAs would nudge students to consider their future earnings before signing a contract and prompt investors to encourage attendance to universities that yield actual returns for both parties: gainful employment after graduation. 

ISAs serve both students and investors, but they also relieve the federal government, and more importantly the American taxpayer, from cyclically subsidizing the student loan market. The Federal Student Loan Program, originally estimated to generate revenue, has cost the country more than $197 billion since the program began. It’s time to stop bailing out a broken system.  

To fix higher education, we must push for an incentive realignment toward the people universities purportedly serve: students.  

Jill Jacobson is a third-year law student at Boston College Law School, a visiting fellow at Independent Women’s Law Center (iwlc.org), and a contributor at Young Voices. 

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