BANKING ON THE FUTURE: YOU

December 16, 2008

What if students repaid loans with a percentage of their future earnings?  The idea of human capital contracts is the next big thing, says Rebecca Tuhus-Dubrow, of The Boston Globe. 

Originally the brainchild of Milton Friedman, human capital contracts are seen as a way to remove the risk of overwhelming debt for students and mitigate the social costs of trying to repay it.  By gearing repayment to income, the contracts reduce those burdens sharply -- a student who earns less money is obligated to pay less back. 

The potentially lower payments explain why human capital contracts would draw students, but there's an attraction for investors, as well, says Tuhus-Dubrow:

  • An education fund offers investors a steady flow, protection against inflation and a more targeted hedge for large employers.
  • Investors could be motivated by philanthropic goals: wealth alumni might see this as a way to help students attend their high-priced alma maters.
  • Foundations and schools could require students to sign contracts stating that nothing is owed up to a certain point, but high-earning graduates would repay a percentage of their income, allowing the foundation to recycle that money into later classes.

Moreover, proponents believe that if human capital contracts became widespread, they could actually influence higher education itself, by pushing schools to better prepare students for professional success. 

However, for all the benefits, the contracts pose multiple challenges in practice, adds Tuhus-Dubrow:

  • They create an incentive for graduates to hide their income and make it easier for them to not work, since no fixed payment is required.
  • Adverse selection and discrimination against low-income students could cause problems.
  • Further, it's not clear how the contracts would be enforced, how the IRS would treat them and what would happen in the case of bankruptcy.

Even though the movement for human capital contracts is still small, with only a handful of companies offering them worldwide, it could be the answer to education financial needs.

Source: Rebecca Tuhus-Dubrow, "The next big thing in student loans -- human capital contracts," Dallas Morning News, December 14, 2008.

 

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