Income-Based Repayment and the economics of higher ed

GULC professor Philip Schrag has a forthcoming review of Brian Tamanaha’s Failing Law Schools that criticizes Tamanaha for failing to acknowledge that Income-Based Repayment, especially in its new form that will become available to most law students as early as next year, “solves” the problem that law degrees now cost much more than they’re worth. (Tamanaha responds here).

In his book Tamanaha presents the case of Sarah, a hypothetical graduate making an entry-level salary of $63,000 (this was NALP’s — needless to say quite inflated — “median” salary for the class of 2010). Tamanaha points out that if Sarah has $100,000 in law school debt she will be unable to service that debt via the standard ten-year repayment plan, and she will still struggle to do so under the 25-year extended payment option. “In 2007, however,” Schrag announces, “the United States Congress solved Sarah’s problem,” by creating IBR.

The new version of IBR, Pay As You Earn (PAYE), has been fast-tracked via executive order by President Obama, who is displaying either a touchingly naive belief in the investment value of higher education, or a ruthlessly cynical willingness to exploit that belief. PAYE reduces the loan payments graduates must make from 15% of disposal income (defined as income beyond 150% of the federal poverty line) to 10%, and reduces the period of payment prior to debt forgiveness from 25 to 20 years (it remains 10 years for those who qualify for PSLF by working in the non-profit sector).

Schrag argues this program makes law school eminently affordable for graduates making moderate incomes, without regard to their debt levels, and that thus it undermines the central thesis of Failing Law Schools, which is that law schools are failing because they cost too much.

Indeed from the perspective of universities in general and law schools in particular, IBR appears to be the budgetary equivalent of manna from Heaven. Note that, if she remains eligible for IBR, it makes literally no difference whatsoever how much money Sarah borrows as an undergraduate and while in law school: she will make exactly the same total loan payments over the next two decades in any case.

Let’s see how this works. Using this handy calculator (which Schrag warmly recommends to prospective law students), we will assume that Sarah gets a $60,000 entry-level job, and that her income will increase by an average of 3% per year over the next 20 years, i.e., she will be making around $108,000 20 years after graduation. If Sarah incurs $100,000 of total educational debt (this assumes all the debt is IBR eligible, which for people who entered college after 2007 it almost certainly will be), she will initially make loan payments of $360 per month, which will rise to $470 after ten years, and be up to $632 when she is making a six-figure income after 20 years in the program. She will make a total of $116,200 in payments over 20 years — the calculator estimates that this is equivalent to about $65,000 discounted to present value — which all go toward interest. In fact she will not have paid nearly $30,000 in the interest she owed on her loans, meaning that she will have $128,775 in debt (all the money she borrowed and then some) written off when her loan is forgiven. This debt will be treated as income by the IRS, and she will have to pay the tax on it to the extent that her net worth exceeds the forgiven amount (Or something like that. Consult a tax law professor or better yet a real lawyer to get the gritty details).

Note that $100,000 in total educational debt is a far lower figure than will be incurred by people currently applying to law school. I estimated recently that the average educational debt of members of the class of 2016 who graduate from private law schools and incur educational debt will be around $205,000. How much will Sarah pay if she graduates with $205,000 in IBR-eligible debt? The answer is $116,200. Her payments will be exactly the same — but after 20 years the government will write off nearly $400,000 ($396,299.07) in unpaid principal and interest (Again, $200,000+ educational loan balances will be typical for people now entering law school by the time they graduate, and $300,000 balances will be far from rare).

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