Balkinization  

Thursday, November 29, 2012

What's Wrong With Income Based Repayment In Legal Academia: A Response to Schrag

Brian Tamanaha

In Failing Law Schools, I argue that the economics of legal education don't work for the bulk of students because the high cost of a degree exceeds the economic return they obtain. In 2011, only 55% of graduates nationwide landed full-time jobs as lawyers; the average law school debt of private law school graduates was $125,000 (not counting undergraduate debt and interest accrued), and the median salary was $60,000. A law graduate who earns the median salary cannot manage the monthly payments on the average debt.

Phil Schrag has written a strong critique of my analysis, which I encourage everyone interested in these issues to read. He criticizes me for directing a "nuclear weapon" at the structure of legal education, when "small arms fire, to curb a few evident abuses, would have been a more appropriate response." The Income Based Repayment program (IBR) solves the economic problems I identify, he argues. IBR allows graduates to make monthly loan payments based upon their income (10% of income above 150% of the poverty rate), and forgives the remaining balance after 20 years. In a section called "Sarah gets rich," Schrag shows that law graduates on IBR end up doing very well. He also argues that, contrary to concerns I expressed, their credit scores (FICO) will not be adversely affected by the fact that their loan balances will remain very large (and in many instances grow), because creditors will care only about their fixed and manageable low monthly payments.

My main confusion, according to Schrag, was caused by a too literal reading of two central elements: I erroneously believe that the ten year "standard" repayment period really is (or should be) the baseline; and I erroneously believe that the statutory eligibility threshold for IBR--"partial financial hardship"--really means that graduates in IBR are suffering from "partial financial hardship." He argues that students in IBR are not in fact in financial hardship. A more accurate perspective, he argues, would see IBR as the "'standard payment' or 'standard payment for high debt borrowers,'" and the 10 year term as "accelerated repayment."

Schrag makes a convincing case. The recently implemented version of IBR is far more generous than the formula in place when I wrote the book (15% of income above 150% of the poverty line, forgiveness after 25%). Under the previous program, a student on IBR would end up paying more each month and a much higher amount of interest on the loan before forgiveness. (Critics of the new formula, from both the left and the right, argue that it offers almost no benefit to low income earners, while being very generous to graduates who earn $50,000 or more.)

It bears pointing out that Schrag's positive take on the situation downplays the fact that the balance forgiven at the end of twenty years is treated as taxable income (a nasty tax bill awaits them), and he is less troubled than I am by the fact that our graduates will not be free of their law school debt until deep into their middle age (when paying mortgages, and saving for retirement and their children's college tuition). But those differences aside, his argument is sound.

That said, in my view IBR does not solve the basic underlying problem of the warped economics of legal education, but actually has the potential to make it worse. I will identify just two reasons to doubt Schrag's assertion that no big changes are necessary.

First, I find it alarming, not reassuring, to be told that IBR should be viewed as the "standard payment" for contemporary law grads. This very assertion confirms the argument of my book that, as a systemic matter for the bulk of law students, the income they earn coming out (and for years thereafter) cannot support the amount of debt they took on to obtain their law degree.

Now, given this recognition, legal educators can take the position that we should engage in fundamental reforms aimed at rectifying this systemic economic mismatch; or we can leave the situation basically as it is and be thankful that IBR saves us from making hard choices. My stance is the former, not just because I believe the economic mismatch has many bad consequences, but also because I believe it is unwise to count on the existence of a government program that might well be cut back or restricted in the budget cutting battles that lie ahead. As Schrag recognizes, the forgiveness aspect of IBR operates as a subsidy for law schools, covered by taxpayers. When this becomes widely understood, at least in Congress and the Department of Education, I doubt that it will enjoy much support.

The second reason for concern is that the operation of IBR exacerbates the situation in several ways. Because monthly loan payments under the program are tied to salary, not to the amount owed, IBR renders the size of the debt irrelevant. For example, a student who owes $130,000 will pay exactly the same amount over the 20 years as a student who owes $200,000 (assuming the same income). Consequently, students might be less concerned about whether law school is a poor economic risk (their downside is limited), and they need not think about the magnitude of the debt they take on because all will be forgiven at 20 years.

Besides encouraging inefficient economic decisions by students, IBR will artificially keep alive law schools that should not exist. There are a bunch of law schools where graduates have debt well in excess of $130,000, only a third or so of graduates land jobs as lawyers, and most grads who land jobs earn between $40,000 and $60,000. Without IBR these law schools would likely go under--or drastically slash their tuition--because few rational students would enroll. Owing to IBR, however, these law schools can entice students by telling them that they should not be afraid of the size of the debt they take on because their monthly payments will be capped at a manageable level and the remaining debt will be forgiven in the end. A number of law schools are making this pitch today (Cal Western is cited as an example in the report linked above). The intended purpose of IBR is to rescue grads who find themselves drowning under large educational debt--but it was not set up to be utilized by schools (fighting for their own survival) as an inducement to persuade prospective students to leap into risky financial waters that will likely leave them foundering.

Finally, the fact that IBR makes the size of the debt irrelevant means that law schools can increase tuition without worrying about adverse consequences for our students. The added debt that follows from tuition increases will not be borne by them because anything added to the bottom line will simply be wiped away at forgiveness.

Law schools benefit from and are happy about these aspects of IBR. But legal educators should also consider whether they are good for our students and for society.

Comments:

I appreciate the difficult problem you highlight toward the end, of how to get the most "failing" of law schools -- the worst outliers whose graduates really have exceptionally poor prospects (and will for the foreseeable future) -- to close. However, I have absolutely no hope at all that, as you argue, absent indirect subsidies, "these law schools would likely go under because few rational students would enroll."

There is (still, even today) a great demand for legal education that significantly outstrips the supply. Lots and lots of people buy lottery tickets, and lots and lots of students will go to law schools where their prospects upon graduation are statistically very poor, even when those poor prospects are thoroughly disclosed. We need a solution to the oversupply of law schools that does not depend on the rationality of students in regard to their long-term future prospects, let alone their long-term future debt obligations, which are simply incomprehensible to many.

What if a sufficiently high bar failure rate led to a school losing its accreditation?
 

Dear Brian,

I very much appreciate your work in this area and have agreed with most of your law school-related posts on Balkinization. But I find your answer to Schrag to be unconvincing.

Schrag's article sets out the extent to which the various student loan repayment programs currently available make law school a far better investment than you and others have claimed. One can believe that the federal government should not be directly subsidizing law students and by extension law schools. I am sympathetic to this argument myself. But surely any determination of whether law school is a sound investment needs to take into account the available student loan repayment options.

You paint an unflattering picture of IBR in your book, but are far more complementary as to other government programs such as the PSLF program. Here you seem to concede that IBR is not nearly as problematic as you portrayed it, but for the question of how it will impact an individual's income taxes after the loan is not repaid but is instead forgiven.

However, you then shift from focusing on students (who, after all, benefit from IBR as presently constitued, even if law schools also benefit) to decrying the peverse incentives that the availability of IBR gives law schools. It can't be, however, that 1) law school is a poor investment for most law students notwithstanding the various repayment options AND 2) the availability of IBR effectively insures against much of the risk of the law school investment, leaving students free to make even irresponsible enrollment decisions and sustaining law schools that you believe should be closed.

I am sympathetic to your claim that law schools have behaved irresponsibly and that current Dep't of Education policy might excarbate excesses. But do you agree with Schrag's key contention that the system we have now is likely better for students and clients than the system you propose (even if it is not necessarily better for taxpayers generally)?
 

Tamanaha's first objection to my warm regard for income-contingent repayment plans is that they might be repealed by budget cutters. He is of course entitled to his political prognostications (which are more likely to come to pass the more he denounces income-based repayment). But I'm sure he noticed that the principal architect of the new PAYE plan was just re-elected President of the United States, while a certain budget cutter who favored repeal and was running for Vice-President was defeated.

And then he turns to the alleged evils of subsidizing higher education - some law schools might fail but for the government's having made it easier for students to attend them, and others might raise tuition. Leave aside that tuition seems to be driven by many real costs such as faculty and staff salaries, technology and financial aid, and that competition for students is a restraint on tuition increases. Is subsidization of higher education a bad thing? (Income based repayment is available for all government loans for higher education: undergraduate loans and loans for all types of graduate schools, including medical and nursing schools, for example). Nearly every type of good and service in the U.S. is cross-subsidized in some way, as a recent Time Magazine cover story (cited in my essay) demonstrated. And not just in the U.S.: higher education is subsidized world-wide, often with direct subsidies, but increasingly through income-based repayment plans, which have the advantage of being progressive (those with higher incomes repay more). Would Tamanaha do away the all the subsidies, including the tax-exemption for non-profit colleges and universities, and the tax deduction for contributions to them? Or state legislative appropriations for graduate education, including legal education, at state schools? These subsidies also help students attend schools (or, from Tamanaha's perspective, help to keep universities from failing). If he would not abolish these more traditional forms of subsidy, why pick on income-based repayment? And while we are at it, would he also eliminate the subsidies that Congress has provided for farm products, the oil industry, airlines, housing, etc.?

Philip Schrag,
Georgetown Law
 

This thread should definitely be read by the House Budget Committee.
 

Phil,

I'm not against subsidies when they are necessary and justifiable. What I question is whether the current costs of legal education--especially the low teaching loads for professors and high expenditure of resources on faculty research at law schools across the board--meet this standard.

Your argument that major reforms to legal academia are unnecessary depends entirely on the assumption that IBR will remain in its current form--and your confidence might well be vindicated. My view is that it is imprudent for legal educators to rely upon IBR to fix our "broken economics."

I tend to believe, perhaps wrongly, that things that don't make economic sense will stop (eventually). The economics of legal education do not make sense for the bulk of our students, as I think your own argument confirms, but IBR keeps it going.

Time will tell whether this will continue.

Milan,

I am convinced by Phil's argument that the new version of IBR substantially eases the debt burden on law graduates. So yes, he makes a good point (as I say).

Unlike Phil, however, I do not think IBR makes everything okay for our graduates. The tax hit strikes me as a serious negative, and I also think it is lamentable that many of our grads will be paying their law school debt until they are 45 or 50 years old. Apparently you disagree, but my continuing concerns about these two aspects are not baseless.

You are right that my focus in this post emphasizes the perverse incentives created by IBR rather than the burden on students. I'm not sure why that is inappropriate or "unconvincing".

In the book I expressed general misgivings about the federal loan program and about IBR. Since writing the book (over a year ago) I have witnessed an increasing number of law schools aggressively pitch IBR. When I wrote the book I did not anticipate that law schools would use IBR in this way. That was naive on my part.

Brian

 

Joey,

Alas, I share your view that students will continue to attend law schools with extremely poor outcomes no matter how long the odds. That's another reason why I think Phil is wrong to argue that no major reforms are necessary.

The main thrust of my proposal is to allow greater differentiation among law schools, opening up a lower cost avenue into the legal profession. Under this approach, the people determined to go to a low ranked law school regardless of poor odds of becoming a lawyer will end up with a lower debt burden when things don't pan out.

Phil opposes my proposal on the grounds that it will create a two tier system. However, the two tier system already exists in legal academia and in the legal profession. We might lament this, but there is nothing to be gained by denying that it exists. My proposal merely recognizes this de facto reality, and tries to bring the price down for the lower tier.

Brian
 

It is worth noting, if only for posterity, that the changes to the IBR program are *not* retroactive.

The cohort that graduated from 2007 (when the ability to refinance student loans at lower rates was eliminated) and this year (the last year before the new IBR), are stuck with very bad loan terms as compared to other cohorts, and graduated into a terrible economy to boot.
 

as far as the tax hit for the debt forgiveness, (for those on IBR in non public service-i.e. 20 years),

it should be noted that if you are insolvent at the time of the forgiveness, (which by definition most of these people will be) the debt forgiveness is non taxable to the extent of the insolvency.

of course tax law can change too, and it usually is retroactive. Further, state income tax regimes might not be so forgiving about the debt forgiveness vis-a-vis insolvency.
 

also im not sure what the proof is that future changes to IBR won't be retroactive. What stops congress from doing that? The master promissory note the students sign makes the loan repayment terms contingent on the law as amended. http://www.direct.ed.gov/pubs/dlmpn.pdf.

for a good discussion of the current tax provisions of the debt forgiveness and the insolvency exception see the IRS's discussion at http://www.irs.gov/publications/p4681/ch01.html#en_US_2011_publink1000244078.
 

Isn't Brian Tamanaha's point that if you go to anything less than a top 75 law school, you had better be an entrepreneur to start your own practice, and you had better recognize that you will be in debt up through late middle age?

All this talk from the Georgetown Law professor is around the edges of Tamanaha's analysis if you go to a Tier 3 or Tier 4 law school.

There are still too many lawyers for too few jobs. And the cost of maintaining a law license, starting with malpractice insurance, office costs (not everyone can be Mickey Haller...:-)), and then the debt burden make lawyering a poor investment in the main these days for young people.
 

In his article, Professor Schrag states that, as a conservative, he thinks any corrections in toal costs or total graduate numbers should be left to the market. But law school education in no way resembles a normal market. The bankruptcy protections allow students to take out ridiculous amounts of debt that (particularly at lower ranked schools) they have little chance of being able to pay back. And now IBR has put the rest of us on the hook for these debts, but has pushed it down the road by 20 years so not many people are really taking notice.

The best solution would be to soften the bankruptcy restrictions. This helps the people that (as mentioned above by Brad) won't be able to take advantage of IBR. It will also reduce the money available, forcing some of the lower ranked schools with truly horrible placement prospects to either close or reduce tuition significantly, and finally, it saves the rest of us the cost of paying for all of this in twenty years.
 

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Just noticed this in Professor Schrag's response above: "Is subsidization of higher education a bad thing?"

Maybe not always, but it certainly can be in some circumstances. There are literally dozens of law schools where the students have a much better chance of ending up unemployed, working part-time, or in some full-time job that probably won't last and doesn't pay enough to cover the loans without some program like IBR. These schools serve no purpose and simply shouldn't exist.

A few examples from my home state of California:

Golden Gate
Tuition (3 years): $121,545
Est. Total Cost: $243,725
Not Working: 29.4%
Working Part-Time: 24.1%
School Funded: 5.8%
Solo: 3.7%

Whittier
Tuition (3 years): $117,000
Est. Total Cost: $241,344
Not Working: 43.1%
Working Part-Time: 14.6%
School Funded: 1.6%
Solo: 4.1%
 

One important piece of the subsidy question is how much of the student loan money is used to fund educational programming vs. how much is redirected to "merit" scholarships. Of course, this is something that Brian has discussed at length in other contexts, but I think it bears directly on the issue of the incentives created by IBR. When UC Hastings published its CFO presentation last year (the weblink has since been removed), it showed that Hastings reported taking in $43 million a year in federal student loans ($23 million Stafford, $20 million Grad Plus)—a large portion of its $63 million revenue stream (and much bigger than the $8.5 million it got in state appropriations). It then budgeted $13.1 million for student grants—essentially using 30% of the student loan funds to provide scholarships for students with (presumably) above-median credentials. If the school ended the merit scholarship cross-subsidy, it could conceivably reduce tuition by one-third and maintain the same revenue stream. Of course, then it would lose students to other schools that continued to offer such scholarships—but that is a collective action problem, and one that could be affected by federal lending regulations.

I wish there were more data available about what other schools are doing with merit scholarships--but I suspect that many or most schools have significantly increased their scholarship budgets in an effort to maintain credentials, and (as Brian has written) these subsidies tend to reward the students who are already in the best position to be successful in law. Are they the students we want to subsidize? And if GradPlus lending were limited to, for example, $20,000 a year, meaning that schools could no longer afford to cross-subsidize the same level of merit scholarships, could nominal tuition decrease? Might this have a net positive effect on overall debt levels--or, at least, on how equitably those debt levels are distributed?
 

George Weiss: "it should be noted that if you are insolvent at the time of the forgiveness, (which by definition most of these people will be) the debt forgiveness is non taxable to the extent of the insolvency."

Are you actually making the argument that law school is a good investment because personal bankruptcy will take care of the debt?
 

no I am merely complimenting the discussion of the tax consequences of IBR with another important fact that was omitted.

my opinion of the greater issue was omitted on purpose.
 

George Weiss: "also im not sure what the proof is that future changes to IBR won't be retroactive. What stops congress from doing that? The master promissory note the students sign makes the loan repayment terms contingent on the law as amended. http://www.direct.ed.gov/pubs/dlmpn.pdf. "

Good point. Anybody on IBR is basically living off this program not being sharply cut or eliminated in the next decade.
 

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Barry:

I would just note that I think that congress could possibly take away IBR retroactively-thereby screwing those already on it with higher payments and no forgiveness.

but im not sure if there isn't some block to that as a matter of taking law (if the terms of the loan are now somehow vested property rights) I just don't have the constitutional knowledge to determine that.

on the other hand two related points:

1) when it comes to such programs, congress historically has always made changes not retroactive-which is a good thing for people on IBR i guess. (see eg changes to social security medicare federal retirement benefits etc).

2) even if congress changes it prospectively to eliminate the program, it can still screw over 2Ls and 3Ls who would be stuck with a choice taking two years of loan for which IBR does not apply, or leaving law school with one year of debt and no degree.
 

I see your point & it highlights the perversity of the situation. After 25 years, my husband and I will have paid $150k on our $120k in loans and have about $140k "forgiven". At our current income levels we will be insolvent at that time. I'll be 53, he will be 57. We'll have paid $150k over 25 years amounting to not even enough to cover the interest AND we will STILL be insolvent.
 

Damn, I love this IBR plan. Now that I'm 68, I'll be able to go to law school, maybe later even med school, for free, since I earn less than 150% of poverty level!
 

Phillip Schrag: "Tamanaha's first objection to my warm regard for income-contingent repayment plans is that they might be repealed by budget cutters."

Hmm ... that didn't take long:

"The bill would also eliminate income-based programs that forgive loans entirely after 20 or 25 years -- and, after 10 years, for those who enter public-service careers, such as teaching or law enforcement."

http://www.bloomberg.com/news/2012-12-04/student-loan-collection-targeted-for-overhaul-in-congress.html
 

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agree to some extent about the point that many have priviate loans that don't qualify.

but actually we know very little about what percent of the student debt out there of lawyers is private.

since you can borrow to the limit of tuition plus living expenses with grad plus there is nothing forcing people to take private loans-except those who have a smaller amount of private from undergrad.
 

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