Policy Watch: Income-Contingent College Loans

We consider the recently proposed "income-contingent loan" (ICL), in which Congress would establish a national trust fund from which students could borrow money to finance the cost of attending college; students would repay these loans by contributing a fixed proportion of their subsequent income for a specified number of years. One key issue is whether proposed income-contingent loan plans will be self-financing; that is, will the value of loan repayments cover the initial cost of providing the loan? What about adverse selection? And how should income be defined for purposes of an income-contingent loan plan? In essence the typical income-contingent loan proposal involves three parameters: the amount of the loan; the period over which income is "taxed"; and the rate at which income is taxed. At what level must the tax rate be set for an ICL plan to be self-financing? We present several illustrative calculations that might be useful to those who wish to evaluate various proposals and present some conclusions.