Using Student Loans to Slow Tuition Growth

It's back-to-school time for college students, which means big tuition bills. Most will defer large out-of-pocket costs until after college through the use of student loans. No one is happy about the explosion in student loan debt to pay rising tuition, but there is a silver lining: We can use student loans to slow tuition growth.

There are two sides to the college affordability ledger: financial aid and tuition. Politicians focus almost exclusively on expanding financial aid, which is crucial, but it's like chasing a rabbit. Tuition outpaces inflation, grant aid, even health care cost growth, and, most importantly, median family income. To keep pace with rising tuition, student loan debt doubled over the last decade.

To slow tuition growth, supply-and-demand incentives have to change. If suppliers are on the hook for a portion of student loan default costs, they'll be less likely to run up tuition beyond what they can expect students to repay. If consumer demand can be nudged at the same time toward colleges that are good investments, schools that offer poor value at a high price will have to slow tuition growth and improve student outcomes. We shouldn't regulate tuition; we should nudge it in the right direction.

Colleges, because their mission rightly is to build and diffuse knowledge, have insatiable growth aspirations. Many will raise tuition as much as the market will bear, and it bears a great deal.

But families choose colleges and borrow almost blindly. They have relatively little information as to how good an investment a particular school is. Ranking guides like that of US News & World Report focus on the top 20 percent of schools and inputs like class size as opposed to outcomes like how much students learn.

If colleges are made responsible for a portion of student loan default costs, they'll be more responsible in who they let in, how much they charge, and how well they prepare students for good-paying jobs that enable those students to pay off their debt. In the private student-loan market, banks are increasingly placing proprietary colleges on the hook for a portion of student loan default costs. The federal student loan market is five times as large. We need recourse there as well.

There's a danger colleges will respond by pricing their exposure to defaults into even higher tuition. That's why we also need to nudge demand away from high-cost, poor-value schools.

Most colleges supply a good product, and shouldn't be penalized simply for serving high-risk populations. But a subset of schools is clearly not serving students well. Community colleges in that group aren't the issue here, because of their low cost and low borrowing rates. The real problem is with low-level private institutions and shoddy for-profit trade schools. We should steer students away from them, but how?

Few Americans want to see No Child Left Behind-like testing at the college level. But it's relatively easy to compare colleges according to what students most want out of higher education: good jobs and financial security.

We need a price-to-earnings ratio—that is, price of college to expected future earnings—for higher education. The US Department of Education has the average net price for each college. It can generate lifetime student default rates for each school as well. A private website, Payscale.com, lists median starting and mid-career salaries for hundreds of schools. Put such data together and construct a higher-education value index, including a "lemon list.'' Just like politicians have to say they approve campaign commercials, make the lemons warn consumers on their marketing materials.

"Warning: One in two Acme College borrowers defaults on a student loan within three years of separation from Acme College. Acme graduates earn an average starting salary of $22,000 a year. Be careful before assuming substantial student loan debt to attend Acme College.''

Schools will want to be identified as good-value options and shudder at the prospect of being on a lemon list. To avoid it, they'll be less quick to raise tuition—and more interested in making sure their students get good-paying jobs.