outcomes-based funding

The student loan crisis won’t disappear unless we tackle the root cause

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Aug 6, 2019

There’s been no shortage of potential solutions to the student loan crisis from politicos lately: “free college” and loan forgiveness efforts topping those most popular in the media. But there’s one solution that not only offers potential students a measure of security against taking on loans they can’t pay off, but also protects against spending time on an education that doesn’t align with workforce needs: outcomes-based funding.

Why outcomes-based funding addresses the root cause of the student loan crisis

Outcomes-based funding makes dollars contingent on performance on metrics like graduation rates, job placement rates, and wage growth. Thirty-six states now use some degree of outcomes-based funding, but federal support for college continues to be a pay-for-enrollment system. The goal of outcomes-based funding is to concentrate investment in programs that achieve a strong return on investment (ROI) for students and defund programs that don’t work. 

In the prevailing federal pay-for-enrollment model, colleges receive money for every student they enroll. The school gets to keep financial aid dollars—even if the student fails their courses, drops out after the end of the semester, doesn’t go on to finish their degree, or isn’t able to use their education to get a job that enables them to pay off their loans. And as long as students are enrolled in an eligible degree or certificate program, they can receive a Pell grant or apply for a loan. 

Because this practice allows students to enroll in programs with no safeguard against low course-completion and graduation rates, inevitably, some students end up with debt that they struggle to repay. With pay-for-enrollment, the government ends up investing taxpayer dollars in programs with a low return, whether measured by loans repaid or by social benefit. Individuals bear the cost—in terms of student loans and lost time—of having attended a low-quality program, but all of society pays for defaults and lost human potential. 

“Free college” and loan forgiveness programs take the burden of loans off of individuals, but they don’t address the underlying problem of high costs and low-quality programs—and they don’t create any incentives for our higher education system to improve. What the promise of “free college” fails to consider is not just whether it expands access to those who need it most, but also whether a narrow solution to tuition cost ignores the more critical question of value. In other words, offering access to something broken does not make it better.

Other solutions to the student loan crisis, such as whole or partial loan forgiveness, may help graduates today, but certainly not in the future. Not only does higher education’s current funding system rely on a pay-for-enrollment mechanism that doesn’t protect students against poor ROI,  but current accreditation relies on inputs like faculty degrees and shared governance. This input-driven approach results in higher costs, as schools add complexity and features in order to meet accreditation standards. Combining higher costs with a pay-for-enrollment model ultimately means students will continue to take out loans for the foreseeable future to continue enrolling in increasingly pricier programs that offer no protection against the inability to pay off those loans post-graduation.

3 outcomes-based funding models

Outcomes-based funding models could change institutional behavior in ways that benefit students—and could replace a complex and arcane regulatory framework that has limited innovation and been ineffective at protecting students and taxpayers from waste, fraud, and abuse. The outcomes-based funding models could focus on:

1. Risk-sharing. Congress could authorize risk-sharing, whereby colleges would have to repay some financial-aid dollars if students default on their loans. This trial could comprise a set of experiments that test the effects of varying percentages of risk on the college’s part. 

2. Performance in the market. Congress could also make funds more available to providers that produce relatively strong outcomes, which would create more liquidity for programs that deliver a higher return for students and would naturally guide students toward them. Access to funding wouldn’t be based on whether a program cleared an arbitrary debt-to-income ratio of its graduates but on the performance of a program relative to that of other schools and on actual market conditions.

3. ISAs. Congress could support legislation to clarify the market for income-share agreements (ISAs). ISAs are contracts in which students pay back a set percentage of their future income for a limited period of time—where, through a similar risk-sharing mechanism, some college revenues would be contingent on a student’s future earnings. ISAs have the potential to reduce risk for students, as well as to align the incentives of schools with student outcomes. 

To illustrate how this might work: If a program was eligible for $50,000 in federal financial aid to educate one student, it would receive only 75 percent of that sum upfront. When the student graduated, she would begin paying back the federal government a certain percentage of her salary—perhaps 10 percent over a set number of years. Once the student had paid the government $50,000, the institution would receive the remaining 25 percent of the federal money. 

ISAs can also operate in the private market, without using federal dollars—and we are seeing this market grow tremendously.

Where to start

This type of regulatory approach could be applied broadly across higher education to beneficial effect. But one can anticipate that traditional institutions will fight and try to water down these new regulatory attempts. For political reasons, innovative programs, like competency-based programs and bootcamps—which don’t fit well in the existing Title IV framework anyway—could, therefore, serve as the guinea pigs for such policies. Doing so would be in their own self-interest and would also advance higher education overall. 

In exchange for the freedom to operate as they see fit (that is, with waivers from input-based regulations) and still receive federal financial aid, innovative programs would be funded based on their outcomes—which is how functioning consumer and business markets ultimately operate. Providers that innovate and deliver outcomes will tend to grow, while those that innovate but don’t deliver will fade. Over time, as innovative providers gain market share and serve more students, and as we learn which outcomes-based funding mechanisms work best with the fewest unintended consequences, the policies can be extended to more of the postsecondary market.

Alana leads the Institute’s higher education research and works to find solutions for a more affordable system that better serves both students and employers. In this role, Alana analyzes disruptive forces changing the higher education landscape.