Oct

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Income-contingent loans and the Productivity Commission

October 5, 2008 | 2 Comments | Joshua Gans

I have been working my way through the Productivity Commission’s report on Paid Parental Leave. In it, they consider the Chapman-Higgins-Lin proposal for income-contingent loans (ICL) as a supplement to government provided paid maternity leave and dismiss it; despite its ‘conceptual elegance.’ Their argument is surprisingly weak and timid.

Lets start at the top. The term ‘conceptual elegance’ itself is dismissive. It is like the ‘elitist’ tag to Obama. But the scheme is not merely conceptual; it is practical with two decades of positive and practical implementation in Australia and elsewhere.

The next argument against ICL is that people will have a disincentive to earn income and repay the loan. So let me get this straight, people will move to incomes — almost at poverty levels — rather than repay a $15,000 debt? There is no evidence that those with University degrees did this for much bigger levels of debt. Why would you think that ‘moral hazard’ would take place now? The PC then argue that the debt could be capped at low levels but this would still create some sort of work barrier for low-income households. Again, this is implausible.

The PC notes that the loan is the biggest subsidy to those least likely to pay it back. Of course, that is a consequence of subsidising those who most need the loan. Moreover, that is COMPLETELY THE POINT of having an ICL because it has to target the most liquidity constrained. The PC terms this ‘adverse selection’ although they are using what could best be described as a non-standard definition. More commonly, it means that the loan will only be taken up by those not intending to repay it. However, that is not the same as providing loans to those most in need.

Then there is a kicker: “[t]o the extent that there is a failure in capital markets, then this would imply an income contingent loan should be available for any purchases of young families not just paid parental leave.” What? The point is that a family can’t just rock up to a bank and say “I am thinking of taking 6 months off work to care for a baby. I know I have other debts and there is no guarantee our household income will return to previous levels but please give me a loan to cover me.” They can get loans for other situations but not this one. That is why there is a role for the government. Guess what? It is to step in where private incentives are low because of moral hazard and adverse selection not to lament those issues.

And they go on: “there is no guarantee that prospective borrowers would use the loan to finance additional parental leave … rather than for non-parental-leave purposes.” So what? How is the PC’s proposal for paid leave or a baby bonus any different? This is not a criticism of ICL at all but of all payments. The same is true of their criticism that getting the scheme a little wrong will be hard to fix.

Finally, the state that the externalities that need to be internalised are all covered by their other scheme so there is no need for anything more. Let’s be clear here, the PC looked at the evidence, concluded that 6 months of parental-exclusive care was desirable and then proposed a mechanism to get 18 weeks of that. Exactly how does it conclude that all of its identified externalities have been internalised?

Providing ICL as a supplement to income for paid parental leave was one of those ideas that had a clear rationale, a proven track record and would not involve much of a subsidy from the childless to the childful. On efficiency and equity grounds it deserved close attention by the PC. In the end, for reasons I can’t fathom, they opted for irrelevant or non-specific criticisms to dismiss it and proposed a policy that was minimalist, complex and not at all innovative. At least in its draft, you would have hoped that the PC would have been bolder.


Comments

2 Responses to “Income-contingent loans and the Productivity Commission”

  1. Kevin on October 6th, 2008 3:03 am

    I agree with your reasoning and think that most times these sorts of “excuses” are about trying to find ways to rationalise the reduction in the amount of money paid.

    Let us start from the other perspective. Is it a good thing for a child to have a full time adult to look after it in the first years of its life? Will this investment prove to be a good one for society in terms of the return on investment in the development of the child. If the answer is Yes and if we find that our economic system is stopping this happening then we should do something about it.

    It is not about the mother. It is about the child and if we have Income Contingent Loans then the loans could accrue to the child but if so we should ensure that the money is spent on the child.

    So think of a system that lets the child accrue a loan but the loan has to be spent on the child and the people receiving the loan have to prove they are doing this. If they aren’t then they become liable for any loan taken out.

    Do not try to regulate how the money is spent but do it on a case by case basis where the onus of proof is on the person(s) spending the money on behalf of the child. Paying a mum to stay at home with the child is a good use and as part of the deal she has to “report her time” like any job.

    So “conceptually” the child takes out the loan. This money is spent and before it is spent there is an agreement on how it is going to be spent and there are mechanisms to show that the spending took place according to the contract.

    In practice most cases will be simple and we will have things like the father reporting that the mother was indeed looking after the child properly or if there is no father then a grandparent or if not a grandparent then another responsible adult.

    If the father, or the grandparent or the live in nanny, or the foster parent looks after the child then the mother might be the one that says that the child was being adequately cared for and in that case it might not be the child that accrues the loan but the mother.

    Thinking of the problem not as an income one but as an expenditure one where the people spending the money have to show that it is spent on the child will give an innovative solution.

  2. Chris Joye on October 6th, 2008 9:37 am

    The largely missing private markets to enable individuals to issue equity and debt against their human capital is indeed very interesting. We faced the same problem in the housing market where it has not been historically possible to issue fractional equity claims against the underlying collateral asset as a means to fund your real property purchases. As I understand it, economists have regularly argued for income contingent loans or graduate taxes as a form of funding education finance (see Nerlove (1972, 1975), Barr (1991, 1993), Chapman (1997), van Wijnbergen (1997), Oosterbeek (1998), and García-Peñalosa and Wälde (2000). Furthermore, Friedman and Kuznets (1945) and Friedman (1962) have posited that students should be able to issue equity to underwrite their investments in human capital. And then Shiller has been an aggressive proponent of advocating the development of labour income insurance markets.