Laying Out Student Loan Options for CBO

Around this time of year our friends at the Congressional Budget Office (CBO) begin work on an important but overlooked document: the Budget Options report. As most readers know, the Congressional Budget Office provides official cost estimates for legislation considered by Congress. While these estimates play a key role in congressional deliberations, CBO doesn’t provide them for just any policy proposal. Only bills formally considered by congressional committees are guaranteed an estimate. Requests by members of Congress for other estimates wait their turn in a long line. And CBO doesn’t do estimates requested by anyone other than a member of Congress.

The Budget Options report, however, is the one exception to this process. Usually published in February of odd numbered years, the report contains CBO sanctioned cost estimates for all sorts of policy proposals, including a handful on higher education. Higher Ed Watch has learned that CBO is open to suggestions on which proposals it includes in the report, and so we’ve come up with a few for 2009. Although CBO does not take any position on the policies in the report, the cost or savings information it provides will help inform the public debate on these important higher education issues.

Recommendations for CBO’s 2009 Budget Options Report

• Reform Guaranty Agency Role, Change Subsidies to Competitive Grants

As we have said previously, the role student loan guaranty agencies play in the Federal Family Education Loan (FFEL) program is anachronistic, inefficient, ill-defined and riddled with conflicts of interest that harm taxpayers and students. Their primary function is to serve as middlemen, using federal funds to reimburse lenders for loan defaults. Guaranty agencies are also supposed to oversee lenders, but this role is often compromised because of their close ties with loan companies. Even guaranty agencies’ most useful activities, loan default prevention and rehabilitation, are weakened by conflicting federal incentives and ties to lenders. [See, for instance, this report from The Chronicle of Higher Education.]

If guaranty agencies are to play any role at all in the federal student loan programs, we at Higher Ed Watch believe that it should be refocused to one of preventing student loan defaults. Regardless, the Department of Education should take the lead role in guaranteeing loans and overseeing lenders’ activities.

We would like to see the CBO Budget Options report estimate the costs and savings of this new slimmed-down role for guarantors. As part of this calculation, CBO should include the savings from eliminating the existing set of arbitrary and conflicting fees paid to guaranty agencies, and the return of federal assets they currently hold. The estimate should also include the costs of a new compensation arrangement for guaranty agency default prevention work that uses competitive grants from the federal government.

• Extend The Subsidized Stafford Loan Interest Rate

The College Cost Reduction and Access Act of 2007 enacted a campaign promise made by Democratic Congressional candidates in 2006 to “cut student loan interest rates in half.” In pushing this legislation through Congress, Democratic leaders barely fulfilled the promise, adding a number of caveats (which we criticized here) that limited the benefit considerably. In fact, only one cohort of federally subsidized loans — those issued in academic year 2011-2012 — will carry a fixed interest rate of 3.4 percent. After that, the rate cut expires and students will go back to paying a 6.8 percent fixed rate. The authors of the legislation included this provision because extending the rate cut to additional years was too expensive. (Lower interest rates require higher subsidies to both students and FFEL lenders making the loans).

There will inevitably be political pressure to extend the rate cut for new loans beyond 2011-2012. For that reason, we would like to see CBO include an estimate in the Budget Options book showing just how expensive it would be for Congress to extend the interest rate cut for an additional five years or make it permanent.

• Expand Student Loan Interest Rate Reduction

Instead of subsidizing lower interest rates on federal student loans, Congress might consider better targeting assistance to college graduates with burdensome levels of debt by expanding the student loan interest deduction.

Under current law, lower and middle income borrowers can deduct $2,500 in student loan interest payments each year, which is the annual interest on about $36,800 in student loan debt. The deduction effectively lowers the borrower’s interest rate by his or her marginal tax rate, acting like an interest rate cut. But unlike the rate cut Congress passed last year, the deduction is better targeted because it is not available to higher-income individuals (the cut-off is $65,000 in gross income for an individual). College graduates receive a lower interest rate when they are just starting out, but lose the benefit once they land an upper management or CEO gig.

We would like to see CBO include in its Budget Options report an estimate of the costs of making the student loan interest deduction more generous. For example, the agency should estimate the costs of converting the deduction to a tax credit worth up to 50 percent of $2,500 in student loan interest. Such a policy has the effect of “cutting student loan interest rates in half” but only for borrowers earning less than $65,000. This option is fairer for borrowers and taxpayers than the rate cut enacted last year.

Watch for the Budget Options 2009

The CBO Budget Options report deserves more attention among those interested in federal higher education programs. The estimates it provides help make for a more informed debate on key higher education policy proposals. The 2009 report will be especially crucial, considering all of the difficult student loan issues the next President and Congress will have to confront.

Ben Miller contributed to this post.