Talking Business

The slippery nature of subsidies

Let’s go to school on subsidies.

The starring case study: The student debt crisis.

Naturally, when you subsidize something you get more of it. With subsidized low interest rates on student loans, we’ve spurred more people to go to college than ever before.

But now 40 percent of them use loans to do so, and critics think we’re encouraging overborrowing.

Student debt has reached a not-so-cool $1 trillion. Young people saddled with big loan payments are putting off marrying and having children, and buying cars and houses, and they’re not starting businesses.

But the real lesson about subsidies hides behind deeper questions: Who really benefits from a subsidy? In whose pockets does the money end up?

In the Aug. 15 Rolling Stone, writer Matt Taibbi, notable for his take-downs of the financial industry, catches on to the student loan subsidy game.

One part of the article, headlined

“Ripping off young America: The college loan scandal,”

points out that the fight in Washington over keeping the relatively low 3.4 percent interest rate on student loans is a sideshow.

The real scandal is not, he writes, the cost of the loan, “it’s the principal, the appallingly high tuition costs soaring at two to three times the rate of inflation, an irrational upward trajectory.”

Washington politicians have been slow to tackle rising tuition, although just last week President Barack Obama

proposed a college rating system

that would tie federal student aid to the institutions’ performance.

Educators were lukewarm about it. And based on Taibbi’s article, it will be stillborn in Congress. Democrats get a lot of money from the education lobby while Republicans want interest rates and tuition set by market forces.

In his article, Taibbi links the soaring tuition to the subsidized student loan system engineered by politicians, bankers and educators.

Again, think through the question: In whose pockets does the money end up?

Consider that from 1984 to 2011, according to The Wall Street Journal, median U.S. household income rose 8 percent. But private college tuition is up 100 percent and public college tuition has soared 163 percent.

In the meantime, federal student aid jumped from just $234 million in 1964 to $105 billion today, and taxpayers back that $1 trillion in student loans.

The average student debt is now $27,000.

So say you’re a college president or CFO. And you know that potential students — and their parents! — can easily get a low-interest loan.

Isn’t it just natural to capture at least part of that subsidy? Wouldn’t you raise tuition because your customers can better afford it?

You get your tuition money and the banks get their cut. Graduates are burdened with debt to pay off years down the road with whatever educations they left with.

Taibbi says this is especially egregious in the case of “crappy” for-profit schools.

Educators tell Taibbi they aren’t to blame for the increase in tuition. In part, they’re right. Tuition has risen in recent years to make up for state funding cuts. But that’s just in recent years.

(Educators should look up the work of one of their own: Richard Vedder, who directs the Center for College Affordability and Productivity at Ohio University. WSJ carried

an interview

with Vedder last weekend.)

Despite the protestations of educators, I don’t think they’re immune from playing the subsidy game. It’s a game hard to avoid. It’s played when we buy a house, go to the doctor, and even buy food.

Do you think you really benefit from the mortgage loan interest deduction, a subsidy for the purchase of your house? Or from the Fed’s artificially low interest rates, in essence another subsidy?

Not as much as you think. The seller of the house just raises the price, often enough to wipe out whatever amount you save on taxes or interest payments for several years.

Health care insurance is also subsidized through the tax breaks your employer gets. And by the insurance payment mechanism itself, which makes it appear somebody else is picking up the bill.

Many economists say that’s why health costs continue rising. Hospitals and doctors feel no direct pressure to keep prices down. Instead they just pocket the subsidy.

We subsidize some farmers. But then they often overproduce, which lowers what they get for their crops.

The subsidy should flow to consumers in lower food prices. But raw materials make up a relatively small fraction of the ultimate food product.

The subsidy really benefits food processors, who get cheaper raw materials for their end products.

Subsidies do indeed help people, but keep in mind who wins the subsidy game in the end.

And learn the lesson that sometimes the game ends in disaster. Look at what happened to the financial system when the hyper-subsidized housing market collapsed.

The student loan crisis, Taibbi warns, is “eerily reminiscent.”

• Taibbi also uncovers a possibly more-potent issue: The government could be pushing the use of student loans so hard because, guess what, it makes money.

How? By collecting defaulted loans and resulting additional fees and payments.

On defaulted federally backed Stafford loans, the government estimates that its default recovery rate including penalties is more than 100 percent. Collection costs reduce that a bit.

And the default collection rate is much higher than the 15 percent rate on credit card debt. “Student-loan debt collectors have power that would make a mobster envious,” says Sen. Elizabeth Warren.

In the end, Taibbi reports that the Department of Education’s 10-year revenue projection on its loan programs is an astounding $185 billion.

Obama, Taibbi’s article notes, criticized private lenders for making $86.7 billion from student loans over 10 years while not mentioning the government’s haul.