Hidden Grants

A two-day rulemaking session started this Tuesday at the Department of Education. On the agenda is investigating whether the generous student loan repayment plan known as Pay As You Earn (PAYE) should be extended to borrowers who are currently ineligible. This session comes on the heels of a recent Politico report that raised concerns about the increasing cost of the student loan program.

The report revealed a $21.8 billion budget shortfall in student loan revenue, sparking a range of reactions. Some argued that adjustments to profit estimates are to be expected and that, regardless of the shortfall, the program is still profitable. Others argued that $21.8 billion is a significant cost to the taxpayers that cannot be swept under the rug. Still others say that this adjustment is a one-time occurrence due to Obama’s recent policy changes regarding the terms of PAYE and loan forgiveness. If the DOE recommends further extensions to repayment plan eligibility, then this profit shortfall certainly won’t be one-time thing.

Of course, this debate re-opened the tired discussion of which accounting method should be used to determine the “real” cost of the PAYE program. Some, like Senator Deb. Fisher of Nebraska, argue that using the fair value accounting method would better reflect the cost of the program. This method makes the program look more expensive because it factors in the cost of the market risk. Others argue that the current accounting method is best since the lender is the government and the associated risks are different from those in the private market.

While these discussions are important, I think we are missing a crucial point. The loans that are been forgiven are essentially hidden and elusive grants: it is unclear who will most benefit from them. While increased funding for well-targeted Pell Grants is part of the government’s annual budget (which has to be approved and often fought over), these new repayment plans and forgiveness benefits are a matter of regulatory policy. This means that we are unaccountably doling out hidden grants. In some cases the forgiven loan can amount to much more than the maximum Pell. If we need to offer such great bailouts so that students do not default on their debts, then the government must be enabling the lending of bad loans.

Will Massachusetts finally have a Children’s Savings Account Program?

Not since the 1970s when IRAs and 401(k)s were created to encourage retirement planning has the issue of savings raised so much interest. Bill after bill is being filed on Beacon Hill to provide incentives for Children’s Savings Accounts (CSA) and college savings. Here is the current list:

1. SD 1132 An Act to create a college savings program for every child born in Massachusetts. Sponsored by Senator James B. Eldridge (D-Acton) – An act to establish a state-wide Children’s Savings Account (CSA) program. Every child born in MA would automatically get an account seeded with $250. Accountholders with income less than 250% of the federal poverty line would receive an annual match of up to $250 per year ($1 match for $1 deposited). Note: The same bill is also sponsored by Representative Tom Sannicandro (D-Ashland)- HD 2198 For legislation to create a college savings program for every child born in the Commonwealth
2. HD3165 An Act relative to strengthening and expanding affordable, quality higher education opportunities for residents of the Commonwealth Sponsored by Representative Tom Sannicandro (D-Ashland) and Senator Michael O. Moore (D- Millbury). An act to establish a college savings pilot program for low-income families in MA. The families will receive a saving incentive (a match grant). A Trust Fund hosting $2,500,000 will be established to finance the program until June 30, 2016 ($1,500,000 will be expended for the saving incentive match grant).
3. SD1313 An Act to establish a commission to study the feasibility of creating and funding a universal children’s savings account. Sponsored by Senator Sonia Chang-Diaz (D- Boston). An act for Children’s Savings Account (CSA) for College pilot program, giving Boston families a new tool to help save for college. The program will be overseen by the city’s new Office of Financial Empowerment. It is likely to be an RFP process, which schools will apply to. EOS foundation will provide funding to seed the accounts. Note: Mayor Walsh has agreed to establish the program; it should start in the beginning of 2016.
4. SD629 For legislation to promote personal savings. Sponsored by Senator Benjamin B. Downing (D-Pittsfield) An act to enable banks and credit unions to conduct savings promotion raffle: the chance of winning a prize if a minimum specified amount of money is deposited in a savings account.

With all this smoke there has to be a fire. Democrats and Republicans alike can appreciate measures that require low-income, perhaps welfare families, to put some meat in the fire by saving. Let’s get something done before Massachusetts is the last state left without a children’s saving plan.

A Lottery You Can’t lose

Imagine that you have a low-paying job but still manage to save a little for your kids’ future every month. Then someone comes along and offers you a chance to win a cash prize. You just have to put your interest into a pool from which the prize is made. Would you do it? My bet is you would because today’s interest rates are so low that you would be giving up a little for the chance to win a lot. That’s prize-linked savings in a nutshell, and it could spur a lot of people to save.

It is very encouraging to witness the increased interest in motivating low-income households to save and accumulate wealth around the nation. Scholars like Michael Sherraden have helped us understand how the lack of assets is one of the main factors preventing low-income families from upward economic mobility (read more about Sherraden’s work here). First, the Individual Development Accounts (IDAs), then the Children Savings Accounts (CSAs) and matched 529 college savings accounts, and now there is yet another exciting development: prized-linked savings (PLS).

PLS is a powerful idea based on the premise that savings can be made more fun and attractive when merged with the logic of the lottery. Compared to traditional savings accounts, PLS accounts do not earn interest. The interest accrued on all the accounts is pooled and periodically distributed as prizes to its participants. It is essentially a no-loss lottery.

PLS has the potential to kill two birds with one stone.  You’ve probably heard the lottery referred to as the poor man’s tax. Low-income individuals invest large sums hoping to win the jackpot. In one of the poorest town in Massachusetts, the average resident spent $1,179 on lottery tickets a year! With PLS, this amount would be saved and if lucky, the individual might still win a prize. PLS is also powerful because it has the potential to attract those who traditionally do not save. Harvard Prof. Peter Tufano (now Dean of the University of Oxford’s Saïd Business School) has studied, tested, and promoted the idea with his organization Doorways to Dream (D2D). He found that 56% of PLS participants were non-savers before joining such a program. When 44% of American households live in a state of persistent financial insecurity, any savings can make a big difference.

One important obstacle to establishing PLS in the United States is the laws which limit lottery activities to the state-sanctioned lottery. But President Obama signed bipartisan legislation leaving it up to states to decide. Ten had already passed legislation allowing PLS at their banks. And now it seems that Massachusetts may be next. Pittsfield State Senator Benjamin Downing has recently put forward a proposal that would allow banks and credit unions to conduct savings lotteries. Now let’s see if the Legislature and Governor Charlie Baker approve the changes that would make PLS a reality here in Massachusetts.

If there is $21.8 billion shortfall and no one is around to notice it, does it matter?

So we all bicker about every dollar spent on Pell, but a $21.8 billion shortfall for the student loan program goes unnoticed? It goes unnoticed because this adjustment doesn’t need an approval from Congress; it is just noted in the budget (and in a rather confusing manner, if I may add). Just yesterday I went over the budget and I told myself: ‘I need to double check these numbers, it cannot be right’. But, they were… and Michael Grunwald’s article on Politico Magazine explains it all. However, the tables are so confusing that people are tweeting about the possibility that there is another nine billion adjustment that should be added on top of the $21.8 billion. See below:

It turns out the $21.8 billion is the total adjustment after all, but as Doug Criscitello rightly wrote: this only illustrated the need for more transparency.

Also missing is accountability. Of course we all know that Obama is offering and expanding generous repayment plans and forgiveness clauses to ease the financial burden felt by so many families. This might be necessary, but also short-sighted. We need to discuss the long-term cost of the student loan program. And I am not only talking in terms of tax-payers dollars. I am referring to the perpetuation of a borrowing culture, where we tell our young minds that it is ok to borrow. Nobody seems to want to discuss the long-term implications. Colleges like it: they can increase tuition and students will easily borrow a couple extra thousands. Politicians like it: they don’t have to ask for more appropriations to fund the grants. Tax-payers may not like it, but as the above paragraph shows, it is very confusing and difficult to follow… For instance, did I mention that even after this adjustment the student loan program is still profitable (well actually, it might not be, this is another confusing and contentious issue – there is two accounting methods yielding to different results). But again, the more complicated and less transparent, the better…

My take on the proposal to simplify education related tax breaks

In the grander scheme, even if Obama has good intentions, he is sending the wrong message. He is perpetuating a culture that encourages borrowing over savings. Obama’s plan signals that it is OK to borrow and that there is no need to fear inability to repay after college. The Pay as You Earn Repayment (PAYER) plan was already a good deal, and now his proposal further encourages students to borrow (possibly excessive amounts) hoping that a large portion of their student debt will be forgiven and exempt from taxes. This only helps solidify the already existent moral hazard problem.

In juxtaposition, Obama seems to have given up on the idea that low-income families can accumulate wealth or save for college if they are given the opportunity to do so. While it might be true that higher income families are the current 529 account holders, it doesn’t have to be like that. How did Obama’s progressive team miss all the momentum that Children’s Savings Accounts have gained at the state level around the country? Obama’s plan to end 529 tax benefits would have been better received if he had proposed to allocate the money saved to progressively match the 529 deposits made by low- to middle-income families. After a week of backlash, Obama announced that he will not go through with his 529 proposal, which is truly a missed opportunity.

A Community College Formula: Free tuition + Pell Grant + Savings

You might think that President Obama’s $60 billion offer to make community college free would be enough. It’s not.Even on top of the other government grants the average student gets, there is still a $4,325 gap.

The average cost of attendance for students in community college is $16,325, broken down as follows:

• Tuition and fees: $3,347
• Room and board: $7,705 (average cost among public two-year college students who choose to live off campus)
• Books and supplies: $1,328
• Transportation: $1,735
• Other expenses: $2,210

The “free” in free tuition offered by the President will amount to $3,500 on top of existing government grants of $8,500. That adds up to $12,000, which leaves the typical community college student a good deal short.

But don’t despair. If a family saves just $25 per month starting when their child is in elementary school, they can just about close that gap. It is commonly thought that low-income families can’t save. In fact, these families account for the flow of billions of dollars each year in remittances to families abroad ($120 billion per year), lottery sales ($60 billion per year) and other expenditures. Low-income families may not bank these amounts, but the figures show that the dollars are there.

The President pledged, several times, that the government will be there for those who strive, and that is a good thing. Unfortunately, most of Obama’s educational proposals will help debtors, not savers. Here’s why this matters: It’s one thing to make it easier to borrow, as the President did last fall, when his administration loosened the credit requirements needed to obtain federal PLUS loans.

But it’s another thing to motivate families to save for college in the first place, so that getting an education isn’t a guarantee of acquiring loads of debt.

Many states seem to have recognized the shortcomings in incentivizing saving at the federal level. In response, they have passed legislation to offer such options as Children’s Savings Accounts (CSAs), which encourage all families to save for college by offering saving matches, among other incentives.

There is another factor at play with community college students: A significant number of them support their own families. The more they owe, the more they have to work. That means these students have less time to study and are more prone to dropping courses or entire semesters, ultimately prolonging their college careers. What’s more, for the many students who get placed in remedial courses that make up for poor college preparation during high school, this burden is particularly heavy. Remediation courses don’t accrue credits, but they do eat up Pell Grants. For these students, the gap continues to grow.

Beyond dollars, savings accounts increase students’ confidence that they can go to college. Parents use accounts to signal to their children that college is not just possible, but inevitable. Research shows that students with savings accounts are three times more likely to go to college and four times more likely to graduate, compared with students without savings accounts.

Putting away $25 in monthly savings could come from the loose change put into a jug. It is a challenge, yes, but it is doable. Especially so if our government provides incentives. So, thank you, Mr. President, for wanting to give $60 billion to students. Too bad you can’t also give something to inspire students to jingle their jars with savings.

This piece originally appeared in Cognoscenti on Jan. 30, 2015. Cognoscenti:Ideas and opinions presented by WBUR, Boston’s NPR® News Station.