Income Share Agreement

An Income Share Agreement (or ISA) is a financial vehicle in which an individual or organization gives a fixed amount of money to a recipient who, in exchange, agrees to pay back a percentage of his/her income for a fixed number of years. ISAs have gained prominence as a proposed alternative to the traditional student loan system in American higher education, and a number of private companies now offer ISAs for a variety of purposes, including as a funding source for college tuition.^[1] ISAs are often considered to be less financially risky to a borrower than a traditional private student loan.

Characteristics

All Income Share Agreements involve an investor transferring funds to an individual in exchange for a fixed percentage of his/her future income for a fixed period of time.^[2][3] Other features of Income Share Agreements could include a) an income exemption where the borrower does not owe anything below a certain income, and b) a buyout option, where the borrower pays a fee to exit the contract early. Some ISA investors offer different terms to different student based on their predicted likelihood of success, while others offer the same terms to all students. Potential groups of investors could include for-profit companies, altruistic non-profits, alumni groups, educational institutions, and local, state, or federal governments.^[2]

History

Milton Friedman originally proposed the concept in 1955, in his essay The Role of Government in Education, in which he argued that students should be funded through an "equity investment" such that:

[Investors] could "buy" a share in an individual’s earning prospects: to advance him the funds needed to finance his training on condition that he agree to pay the lender a specified fraction of his future earnings. In this way, a lender would get back more than his initial investment from relatively successful individuals, which would compensate for the failure to recoup his original investment from the unsuccessful.

In the 1970s Yale University attempted a modified form of Friedman’s proposal with several cohorts of undergraduate students. At Yale, instead of making individual contracts for a fixed number of years, all members of the cohort agreed to pay back a percentage of earnings until the entire cohort’s balance had been paid off. However, the system left students frustrated that they were paying more than their fair share, by being forced to make payments on behalf of peers unwilling or unable to pay back their loans.^[4]

In 2013, Oregon legislators passed a bill that would investigate Pay It Forward as a college financing scheme. The model would allow students to attend college tuition-free, and then pay a proportion of their incomes post-graduation to finance the cost of their studies. However, unlike the Income Share Agreement model, Pay It Forward would be publicly funded, and it would offer fixed percentage repayments across all institutions.^[5]

Public debate over the Oregon plan led to renewed interest in equity-based funding models, including a prominent summit on Income Share Agreements at the New America Foundation^[6] and a policy paper from the American Enterprise Institute. On April 9, 2014, Senator Marco Rubio announced the introduction of legislation that would 'broaden the use' of Income Share Agreements.^[1][7]

Advantages

Proponents of ISAs argue that they provide two major types of benefit over existing models of college financing:

First, since investors have an incentive to allow students to pay lower shares of their income when they enroll in high quality, low-cost educational programs, ISAs lead to a more efficient allocation of financial resources between colleges.^[2]

Second, ISAs reduce risk for students,^[8] and therefore act as an insurance policy for graduates with low earnings:

[With an ordinary student loan] my nominal monthly payment is fixed but my income could change or go away altogether (making certainty just a monthly repetition of bad news). With an Income Share Agreement the converse is true: I don’t know what my nominal monthly payment will be over the entire term, or how much I will pay overall, but I do know that I will always be able to afford it.^[9]

Common concerns

Indentured servitude

One of the most frequently cited concerns with Income Share Agreements is that they are a form of indentured servitude. Critics argue that because students owe a percentage of their income, the investor therefore own a piece of the student. For instance, Kevin Roose wrote in New York magazine that ISA companies give "young people in the post-crash economy the chance to indenture themselves to patrons in the investor class."^[10]

However, advocates of ISAs contend that since students have no legal obligation to work in a particular industry, and since it is illegal for investors to pressure them into a certain career, students are no more “indentured” than those with a student loan. In fact, someone with a traditional student loan has less choice than someone with an ISA, because the student with a loan needs to be in a career where they make at least enough income to cover their monthly payment, whereas someone with an ISA can choose to never make any money, and would never owe the investor a dime.^[2][9]

Uncaptured positive externalities

Since Income Share Agreements are priced based on likely economic success, critics argue that programs that are not economically viable but still valuable to society may not receive ISAs. For instance, a Masters of Social Work is an expensive degree, but social workers often are not paid very much. Therefore, investors may not offer Income Share Agreements for social workers given current tuition rates. However, the same argument could be made for those with certain majors in the liberal arts. This risk is mitigated so long as other financing options are available, such as subsidized loans and grants from the federal government.^[2]

Discrimination

As of now, there are no documented cases of discrimination based on race or gender with ISA agreements, but some worry that should ISAs become a more popular model, the potential for discrimination could increase.^[2] While there are already anti-discrimination laws in most financial markets that would likely apply to ISA investors, the question, as of now, has not been completely resolved. Some advocates argue that ISAs are less discriminatory as compared to loans:

Even when everyone receives the same interest rate, loans discriminate intensely on the dimension that really matters: affordability. Under a loan program with the same terms for all borrowers, a group who earns less than another despite having identical qualifications ends up with proportionally lower income after paying off that loan than the other group. To the extent that any systematic difference in income between two groups is unfair, loans in effect amplify the unfairness. If ISAs pool groups with similar qualifications but different income potential, then ISAs will partially address the unfairness that loans amplify.^[2]

Creaming

Some worry that ISAs would have the effect of "creaming" the best students and only fund elite institutions. However, ISAs should theoretically fund all economically viable programs (that is the future income of their graduates proportionately aligns with the cost of the degree), so the only way that could be true is if the vast majority of institutions are not economically viable.^[2]

See also

• Human Capital Contract

References