Jonathan Borba, Unsplash Last month, a Republican Congress and President Trump achieved, if that is the word, a massive budget-reconciliation bill. As is more and more common, a Congress averse to accountability for particular votes crammed the measure full of many agenda items that the majority and the president wanted but chose to vote up or down on them as a package.
Several provisions are relevant to American higher education. They involve the student-loan program, in which the federal government provides both subsidized and unsubsidized loans to both graduate and undergraduate students. Federal grants to needy students, e.g. Pell grants, are only modestly affected, although the Biden Administration’s attempt to forgive much already incurred debt is for now canceled. The focus here is on changes to future student loans.
The subsidizing of graduate education is now limited to $20,500 annually, with a lifetime limit of $100,000. Such loans have been, for many years, guaranteed to colleges by federal-government entities. NPR reports that subsidies not directly given to undergraduates themselves but indirectly to universities to educate them are for now unaffected. But the subsidizing of graduate education is now limited to $20,500 annually, with a lifetime limit of $100,000.
The graduate-school PLUS program, which previously allowed borrowing up to whatever a university charged for graduate education, was eliminated.
The effect of the new loan provisions is best described as a good start. The effect of the new loan provisions is best described as a good start. In elementary economic theory, borrowers look at the terms of a proposed loan and decide, based on its expected net return to them, whether it is worth taking out. The lender considers whether the loan’s expected return is worth the opportunity cost of making it. If that were all there were to it, private lending markets would function well enough: Loans expected to be profitable for the borrower and the lender would be offered and accepted.
What about federal enabling of more lending to college students in particular? Historically, in economics, there are two hypotheses about the value to a person of obtaining a college degree. The first is perfectly straightforward, based on the notion of human capital, the package of skills that a person seeking employment possesses. In this hypothesis, going to college increases what one knows, and what one learns in college directly entails higher productivity in the workforce, thus higher pay. There are some specialties—for example, accounting, engineering, or nursing—where this hypothesis clearly carries much explanatory power. For people who lack the resources to pay for college themselves, government-facilitated borrowing is plausibly a worthwhile government function, since it enables a better standard of living for people otherwise unable to procure the necessary training.
The other longstanding hypothesis is known as signaling. In this view, the very act of completing college indicates certain otherwise unobservable traits—for example, the capacity to do intellectually more challenging or complex work to completion without giving up. This certifies that the would-be employee is likely to be more productive on the job. Get a degree, this theory says, and you prove you can do mentally demanding things. Critically, this theory says nothing about what is actually learned in college. As long as the discipline required to obtain a college degree separates those more capable of achievement in a particular job from those less capable, college serves as a separating technique. You have a college degree? If so, that signifies at least that you can buckle down and do hard work. Better that, the employer assumes, than someone who hasn’t proven he is capable of getting a degree.
If the reason to encourage college degrees is primarily signaling, then enabling more people to go to college should increase compensation, as long, critically, as standards are not diluted to make it easier to acquire the signal. If standards are maintained, only those likely to benefit from the signal will enroll, and, in general, they will be better off, as in the human-capital view, for doing so.
But in economics, the saying has it, all the models are wrong, but some are useful. If we add human frailty, different conclusions are possible. Students can take out loans believing mistakenly that doing so will leave them better off. When schools in turn have no financial stake (as a private lender would) in avoiding bad loans, they simply raise tuition and pocket whatever the student and the student’s lender in combination will pay. The loans clearly benefit the schools, which harvest more revenue, as long as the government in exchange places no limits on school tuition.
And so it is no surprise that the American Enterprise Institute’s Mark Perry, in his most recent analysis of how different prices rise compared to the overall inflation rate, finds that college costs trailed only hospital services (also heavily influenced by politics) in the rate of increase from 2000-2023. This suggests that student loans simply enable colleges to reap more revenue. Whether a college degree improves life outcomes is an open question. If college is mostly signaling, then, as more and more people possess a degree, and as standards fall, the value of the signal declines. If it is genuine provision of human capital, graduates overall will be better off but only in some fields, and even there we might expect private lenders in pursuit of profits to at least partly fill the gap if federal lending disappeared.
Colleges respond to more money available by increasing the price of what they sell, and students frequently misjudge the returns. Colleges respond to more money available by increasing the price of what they sell, and it is likely that, frequently, students misjudge the returns on taking out those large loans to finance degrees that may, as the Wall Street Journal relates, leave them financially far worse off. This happens because the university has an incentive to crank out degrees, even as students are deceived (and what seller would tell potential purchasers that the product is low-quality?) as to the potential of what those degrees will yield.
The limiting of graduate loans will presumably force graduate programs to think twice about how much padding they are willing to tolerate. Given these incentives, which suggest that nominally nonprofit colleges frequently act on the revenue side suspiciously like profit-seeking businesses, we would expect government-loan enabling to facilitate growing student indebtedness and much higher college expenditures. And, as noted, college costs have soared, and this is primarily because of things happening on the supply rather than the demand side. Given the inherent uncertainty of finding a high-paying job even with a degree, the possible tendency toward excessive optimism of students (especially when admitted to prestigious universities), and universities themselves benefiting from the extra revenue enabled by loans and paying no financial penalty for bad student outcomes, government loans make things worse.
The trimming of these programs in the new legislation helps but so far only modestly. NPR also reports that limiting the subsidy to colleges for educating graduate students means that it will be “harder for low- and middle-income borrowers to attend pricier graduate programs.” But that the programs are “pricier” to begin with is the problem. The limiting of graduate loans will presumably force graduate programs to think twice about how much administrative and ideological padding they are willing to tolerate, but the same would occur in undergraduate education as well, loans that for now are unaffected. While it would be better if those higher-education subsidies were curbed as well, the new measures are at least a promising start.
The enabling of increased college revenue, and the ideological monopolization and wasteful administrative excess to which it has contributed so much, is just as much a problem at the undergraduate level. So there is much work still to be done. If politically possible, federal-loan subsidies should be rearranged around the goal of enabling loans to students whose earning capacity can be expected to be genuinely higher only if they can access such funding. Lending, in other words, should target students who are genuinely short of funds and can be expected to do much with the degrees the loans enable. In addition, schools themselves should bear some of the costs, which they fail to bear now, of students who find themselves unable to repay what they owe. Currently universities reap all of the reward and bear none of the risk. More changes beyond the sort just enacted will cause borrowers to be better served and lenders to be more careful.
Evan Osborne has taught economics at Wright State University since 1994.
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Evan Osborne
