1. The Insurance Implications of Government Student Loan Repayment Schemes
- Author:
- Martin Gervais, Qian Liu, and Lance Lochner
- Publication Date:
- 01-2023
- Content Type:
- Working Paper
- Institution:
- Centre for Human Capital and Productivity (CHCP), Western University
- Abstract:
- A large literature examines the extent to which consumption responds to idiosyncratic earnings shocks.1 This paper studies whether student loan repayments serve as a source of insurance, much like government tax and transfer programs.2 Indeed, this insurance mechanism is an explicit aim of formal income-contingent repayment schemes in many countries, where the efficient structure of contingencies depends on such market frictions as moral hazard, adverse selection, and costly income verification (Lochner and Monge-Naranjo, 2016). We use new administrative data that links detailed information on Canadian student loan recipients with their repayment and income histories from the Canada Student Loans Program (CSLP), income tax filings, and post-secondary schooling records to measure the extent to which student borrowers adjust loan repayments to insure against income variation.3 Several mechanisms are available for students to adjust loan repayments in response to income fluctuations: formal, like CSLP’s Repayment Assistance Plan (RAP); and informal, such as delinquency or default. Close to 30% of students are enrolled in RAP soon after graduation, although that fraction falls as incomes rise thereafter. ∗ Gervais: University of Georgia, Athens, mgervaisca@gmail.com. Liu: Brock University, St. Catharines, Canada, qliu@brocku.ca. Lochner: Western University, London, Canada, llochner@uwo.ca. We thank the Statistics Canada Research Data Centres at Western University and McMaster University. Lochner gratefully acknowledge support from the Social Sciences and Humanities Research Council of Canada. 1See, e.g., the survey by Meghir and Pistaferri (2011) and references therein. 2Brzozowski et al. (2010) show that the tax and transfer system in Canada is very effective at absorbing income movements. 3Lochner, Liu and Gervais (2021) document sizable transfers implicit in the CSLP through differences in repayment by expected post-school income. Within 5 years of graduation, nearly 10% of borrowers have defaulted on their debt. In addition, borrowers can make larger payments than required should they experience unexpectedly high income: 40% of borrowers have fully repaid their student debt within 5 years of graduation. Indeed, loan payments are shown to increase in income, more so in early years and for individuals with higher initial debt. More formally, we estimate that on average, an unexpected $1,000 change in yearover-year income is associated with a $30 change in loan payment: from a $50 change the year after graduation, declining to a $20 change 5 years after graduation. Loan repayments are also used to absorb income variation that is more permanent in nature: for borrowers whose income is consistently below or above expected income at graduation, the magnitude of average repayment adjustment is similar to the average yearly response.
- Topic:
- Debt, Education, Economy, Insurance, and Student Loans
- Political Geography:
- Canada and North America