Overemphasized Costs and Underemphasized Benefits of Income Contingent Financing

Abstract

Asymmetric information and moral hazard are often emphasized prominently in the literature studying income contingent financing, such as income contingent loans, graduate taxes, and, human capital contracts. I argue that both issues need not be as relevant in certain contexts. For instance, young students have information about themselves that those providing financing do not, but those financing likely have much more information about the job market and career prospects than young students. As for moral hazard, a short or medium horizon of payments need not be as distortionary as a lifelong horizon because the trade-off between leisure and work at the beginning of a graduate’s career should consider the impact of today’s work on the lifelong value of future earnings. Furthermore, some benefits of income contingent financing, in particular of human capital contracts, are not emphasized often enough. The biggest is the information — and consequent impact in behavior — that a competitively priced contract would provide regarding the future income prospects of studying at different higher education institutions, or following different fields of study.