A Better Idea than Student Loans

Little Janey's starting kindergarten next year, and you're already panicking: Just to afford to send her to a state college, the family may have to take out a second mortgage or live on canned food. What if, instead, investors were able to finance talented young people as they do untested but promising entrepreneurs? You wouldn't have to go in hock to send Janey to State U: Willing investors would give her the money.

A New York investment group wants Congress to modify the tax code and convert college financing from a system based on debt to one based on equity. Human Capital Resources Inc. says students should have the option to get their college money from investors in human capital equity funds, a new type of mutual fund that would pay students' college expenses and repay their investors from the incomes the students earn after they graduate. Instead of borrowing money for college, says HCR Chairman Roy Chapman, students could earn it.

Here's how the system might work: Say Janey would require $50,000 in tuition and living expenses for four years in college. Instead of borrowing the money from a bank, or applying for a tax-supported loan or grant, she would apply to Human Capital Resources for money. If HCR decided to invest in Janey (based on her interests, grades, test scores, participation in extracurricular activities, or whatever criteria the company deemed important), it would agree to finance her four-year tenure. (Since the tax code would treat this investment as income, she would also get enough additional money to pay her taxes.)

She would then enter a contract with HCR. Her academic performance as a freshman would let her 'earn' her sophomore tuition, and so forth, until she graduates. If she can't keep up, HCR could terminate the contract, and reduce her obligation to repay the investment. If she fulfills her academic commitments, however, upon graduation she'd begin paying a percentage of her income to the fund that owned her contract for the first 15 years she's in the work force. (A model developed by HCR would have students repay .22 percent for each $1,000 received, so a student receiving $50,000 would pay 11 percent of her income. Since Janey has already paid taxes on that $50,000, the money she repays to her equity fund should be tax-exempt.)

Equity funds would finance the contracts. Much as mutual fund managers try to minimize their investors' risks by funding many companies in diverse industries, equity fund managers would bundle contracts, thus spreading the risk for investors in newly graduated workers. Not every student, after all, will earn big bucks at graduation; some will no doubt choose full-time parenthood over earning salaries. Chapman says a fund wouldn't need much start-up capital: He estimates a fund as small as $25 million to $50 million (or as few as 500 contracts) would offer enough diversity to attract investors.

Equity funds would be a good deal for parents and students. Families could avoid going into debt to finance their children's education. If Janey earned $30,000 at graduation and saw her income grow at about 5 percent a year, over the 15-year span she would pay about 50 percent less to her equity fund than she would to lenders in a typical student-loan package. Taxpayers wouldn't be on the hook if she defaulted. And if she didn't stay employed the entire time, or worked sporadically, her investors would still get some money as long as she worked.

Chapman and partner Gerard Wendelken have drafted a bill that would incorporate the tax changes to let equity funds form. They're meeting with members of Congress, looking for sponsors. Instead of investing in [educational] access,' says Chapman, 'we ought to support success.'

Rick Henderson is Washington Editor of Reason, a monthly social and political commentary magazine published in Los Angeles.

A version of this article was published in The Washington Times on January 5, 1996.