Moral Hazard and the Sustainability of Income-Driven Repayment Plans

Chao Fu, Xiaomeng Li and Basit Zafar

No 33411, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Income-Driven Repayment (IDR) plans tie student loan repayment to income and forgive unpaid debt after certain years of repayment. We investigate how these features affect one’s career choices through a survey where the same student is asked to select job profiles under various repayment plans. Consistent with our Ben-Porath style model, the survey results reveal that IDR is a double-edged sword. On the one hand, 36% of students underinvest in their human capital under the standard repayment plan relative to their would-be choices in a debt-free scenario; an IDR resembling the Saving on a Valuable Education (SAVE) plan reduces this fraction to 20%. On the other hand, IDRs induce moral hazards: Under a SAVE-like plan, 22% of students choose job profiles with lower initial wages and higher wage growth than their choices in a debt-free scenario, leaving part of their debt forgiven. A simple calculation indicates that this type of moral hazard alone would render SAVE-like plans inviable were they carried out by private lenders; however, government-run IDRs are sustainable due to the government’s capacity to collect individuals’ lifetime income taxes.

JEL-codes: H0 I20 I22 I23 J01 J24 (search for similar items in EconPapers)
Date: 2025-01
New Economics Papers: this item is included in nep-lma
Note: ED LS PE TWP
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.nber.org/papers/w33411.pdf (application/pdf)
Access to the full text is generally limited to series subscribers, however if the top level domain of the client browser is in a developing country or transition economy free access is provided. More information about subscriptions and free access is available at http://www.nber.org/wwphelp.html. Free access is also available to older working papers.

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:33411

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w33411
The price is Paper copy available by mail.

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().