Equity Participation as an Alternative to Student Loans

Luigi Zingales is critical of government subsidized student loans:

Nearly eight million students received Pell grants in 2010, costing $28 billion. In addition, the federal direct loan program, which allows nonaffluent students to get government-guaranteed loans at low interest rates, cost taxpayers $13 billion in 2010-11. Total subsidies to university education amount to $43 billion a year, including around $2 billion in Congressional earmarks — and that does not even include tax subsidies (for college funds); tax breaks (for university endowments, for example); and subsidies dedicated to research. Just as subsidies for homeownership have increased the price of houses, so have education subsidies contributed to the soaring price of college. Between 1977 and 2009 the real average cost of university tuition more than doubled. These subsidies also distort the credit market. Since the government guarantees student loans, lenders have no incentive to lend wisely. All the burden of making the right decision falls on the borrowers. Unfortunately, 18-year-olds aren’t particularly good at judging the profitability of an investment without expert advice, and when they do get such advice, it generally counsels taking the largest possible loan. The stock of student loans has reached $1 trillion, while the percentage of borrowers in default jumped to 8.8 percent in 2009 from 6.7 percent in 2007. Last but not least, these subsidized loans keep afloat colleges that do not add much value for their students, preventing people from accumulating useful skills.

He offers the following solution:

The best way to fix this inefficiency is to address the root of the problem: most bright students do not have any collateral and cannot easily pledge their future income. Yet the venture-capital industry has shown that the private sector can do a good job at financing new ventures with no collateral. So why can’t they finance bright students? Investors could finance students’ education with equity rather than debt. In exchange for their capital, the investors would receive a fraction of a student’s future income — or, even better, a fraction of the increase in her income that derives from college attendance.

He correctly notes that this is akin to a system of voluntary taxation where the beneficiaries of a college education are the ones paying into the funding system. An interesting idea with the following caveat we often here from supply-side types. If the funding system were to receive a portion of one’s future income, would that be a disincentive for those “highly compensated superstars” to work as hard? Perhaps but it does seem to be a decent idea even if it does so as to bring greater opportunities to those who wish to pursue a college education on the hope of becoming a future superstar.