Subsidizing Student Loans

Credit goes to Faux News for a fair and balanced story:

Continuing its march through an agenda of popular legislative initiatives, the Democratic-led House is considering cutting interest rates on some college student loans in half. The House was scheduled to vote Wednesday on the measure, which would help an estimated 5.5 million students who get need-based federal loans. The government pays the interest that accrues on those loans while students are in college. Students pick up the payments after they leave school. The rates would drop from 6.8 percent to 3.4 percent in stages over a five-year period under the House proposal. That would cost nearly $6 billion

Dean Baker notes that this $6 billion is over a 10-year period:

Well, CBO typically makes budget projections over a 10-year horizon. If this was a 10-year projection (I have no idea), then the projected annual cost is $600 million or approximately 0.02 percent of projected spending over this period.

The White House opposes this subsidy. So NOW they get the fiscal responsibility religion! But let’s be fair. Subsidizing student loans is not a free lunch as it will SOMEDAY mean SOMEONE will have to pay more taxes. Of course, this White House is not saying when or whom. The efficiency question is whether deviating from market determined borrowing rates to encourage more people to attend college is a good idea.

Update: Richard Vedder and Brian Riedl oppose this subsidy. Someone might fact check this from Riedl:

Despite persistent claims of cuts, student financial aid spending since 2001 has surged by a staggering 400 percent – from $9.6 billion to $48 billion, according to the Office of Management and Budget. This makes the Office of Federal Student Aid the fastest-growing agency in the entire federal government. Much of this increase has come from an unanticipated surge in the number of college graduates consolidating their student loans (which will lead to large federal subsidies to banks). However, the student aid budget is projected to level off at approximately $25 billion – nearly triple the 2001 level. Congress’s focus on interest rates is curious because current rates are quite low by historical standards. This school year, the variable student-loan interest rate – which was set to jump to over 7 percent – was replaced with a fixed 6.8-percent rate that is lower than in all but six of the past 42 years.

Market determined rates decline and people borrow more? What a shocker! Riedl also argues that student aid has led to an outward shift of the demand curve:

Yet these unending student aid increases haven’t made college more affordable. The average college tuition, adjusted for inflation, has leaped 86 percent for public colleges and 52 percent for private colleges since the 1991-92 school year. Paradoxically, many economists now believe that student-aid hikes actually contribute to tuition increases. Colleges, like businesses, charge as much as their customers are able to pay. So when student aid increases, colleges raise tuition accordingly to capture the additional aid.

Finally Riedl turns liberal asking why do we subsidize those who will one day be rich:

Given that a college degree raises the average individual’s lifetime earnings by over $1 million, $114 per month is clearly an affordable payment on a very profitable educational investment. Perhaps it’s not in our best interest to tax society at large to further subsidize the 24 percent with college degrees and higher lifetime earnings. America faces substantial budgetary challenges: the war on terror and new homeland security costs must be funded, and projections show worsening budget deficits every year. The coming retirement of 77 million baby boomers will send Social Security, Medicare, and Medicaid costs to levels that could require a doubling of all income taxes. In this context, responsible lawmakers should step back and examine whether a new subsidy for college graduates is really a top priority.

Odd – Riedl doesn’t mention all that DoD spending but he does mention other entitlement spending which he advocates cutting substantially. Vedder concedes college is expensive, but he echoes the claim that the rising cost of education is coming from an outward shift of the demand curve fueled by government subsidies. The Riedl-Vedder argument seems to stem from an implicit assumption that the supply curve is vertical as if the incidence of this subsidy accrues to the colleges and their faculty.