Back to Market-Based Rates

WASHINGTON -- In his annual budget request on Wednesday, President Obama proposed a major change to student loan interest rates that would save students money in the short term but eventually make loans more costly for borrowers.

The proposal, which would tie the interest rate on student loans to the government’s cost of borrowing, for the first time since 2006, is one of the only new ideas in annual budget proposal, and one that is already drawing pushback from student advocates. Otherwise, the president’s plan for fiscal year 2014 brings back many proposed initiatives that higher education advocates here praised last year, but that failed to gain traction in a budget-conscious Congress partially controlled by Republicans.

As a result, much of the budget -- particularly proposals that call for new federal spending -- is a politically symbolic wish list of ideas with little chance of becoming law: $8 billion in new money for community colleges from the Education and Labor Departments; a $150 million expansion to federal work-study; and $1 billion for a new competition among states to improve public higher education, among others. Obama proposed increasing discretionary spending on the Education Department by 4.6 percent over all, and increasing the maximum Pell Grant to $5,785 for the 2014-15 academic year.

The president's budget would also continue the administration's recent tradition of not only shielding, but in most cases enhancing, the budgets of federal agencies and programs that fund scientific research and innovation. The National Science Foundation, in particular, would benefit from Obama's view that R&D is essential to the country's economic and competitive future. (See section on science funding below.)

The proposal most likely to become law in the next few months deals with the interest rate on student loans. The interest rate for federally subsidized Stafford student loans -- which don’t accumulate interest while students are enrolled in college -- is now 3.4 percent and is scheduled to double July 1. The increase was originally scheduled for last year, but a coalition of student groups and the Obama campaign successfully pressured Congress to put the increase off a year at a cost of about $6 billion. Student advocates would like to see interest rates remain low, but momentum appears to have shifted in Washington toward a long-term fix rather than a short-term solution.

Although there are some differences, the administration’s proposal has several features in common with a Senate Republican plan to change how interest rates for student loans are calculated by tying it to market interest rates. Interest rates would not be capped, meaning that if overall interest rates rise, student loan interest rates could rise with them.

The proposal would peg interest rates on student loans to the yield on 10-year Treasury bonds plus a few percentage points. How many percentage points would depend on the type of loan: the interest rate would be the 10-year Treasury yield plus 0.93 percent for subsidized Stafford loans, plus 2.93 percent for unsubsidized Stafford loans, and plus 3.93 percent for PLUS loans for parents and graduate students.

Since interest rates are right now at historic lows, that would lead to interest rates below current levels for all loans right now -- unsubsidized Stafford loans now have an interest rate of 6.8 percent, and the rate is 7.9 percent for PLUS loans. But as the economy improves, interest rates are expected to rise -- meaning the proposal is a good deal for students in the short term but for the government (as the lender) in the long term, since rates could increase above current levels.

Unlike a bill introduced Wednesday by three Senate Republicans, Richard Burr of North Carolina, Lamar Alexander of Tennessee and Tom Coburn of Oklahoma, Obama’s proposal would keep subsidized loans for low-income undergraduate students with a lower interest rate. That bill would have established an interest rate for all new loans at the 10-year Treasury yield plus 3 percent.

“This is a gesture on loan policy the administration feels would be acceptable to Republicans,” said Jonathan Fansmith, associate director of the Office of Government Relations at the American Council on Education. “There’s not a lot in there that’s particularly protective of or generous to students -- even in a healthy economy, not a booming economy.”

Student groups, which have generally supported Obama’s higher education proposals, criticized the interest rate plan on Wednesday.

“Without a cap, this proposal falls far short of the comprehensive reform to student loans that we need,” five groups representing young voters -- the National Campus Leadership Council, Rock the Vote, U.S. Public Interest Research Group, Young Invincibles and Our Time -- said in a combined statement. “Students have never taken out federal student loans without a cap on how high interest can go. The President stood with us by investing in higher education during his first term, and we're concerned that his budget does not deliver the same investment this time around.” (Note: This paragraph has been updated to correct the signatories of the letter.)

Representative George Miller, a California Democrat and the ranking member on the House Committee on Education and the Workforce, urged postponing an interest rate fix until the Higher Education Act comes up for reauthorization at the end of the year. "At a time of historically low interest rates, skyrocketing college costs, and recent graduates facing a tight job market, Congress should not let student loan interest rates double at this time," Miller said in a statement. "I believe that a long-term solution on student loan rates is best addressed as part of Congress’s efforts to reauthorize the Higher Education Act."

Representative John Kline, a Minnesota Republican and the committee's chairman, said in a statement that he supports a market-based interest rate but "the devil is in the details." 

The administration estimated the change to interest rates would cost $25 billion in the first 5 years, but over 10 years would eventually generate $14 billion in revenue for the federal government.

Big Plans for Campus-Based Aid

The budget also appears to follow through -- at least modestly -- on a proposal in this year’s State of the Union address to encourage alternatives to traditional accreditation systems for higher education. The Education Department’s Fund for the Improvement of Postsecondary Education will seek to support development of “third-party validation systems” for competency-based learning, which awards credit based on what students know rather than on the amount of time spent in class, as well as ways to direct federal funding to programs with good student outcomes that bypass normal accreditation routes.

The administration also revived several proposals from last year’s budget plan that failed to get traction in the Senate, among them a $1 billion “Race to the Top” to encourage states to invest in higher education, new spending on community colleges and a vast expansion of campus-based financial aid programs.

If approved by Congress, Obama’s plan would spend $8 billion over three years on job training at community colleges, with half of the money from coming from the Education Department and the other half from the Labor Department. But community colleges were promised big new federal spending several times during the president’s first term, and the money never materialized. The job training fund, which would focus on workers in high-demand fields, was first proposed last year, but Congress didn’t support the idea.

The budget plan also would revive a proposed $1 billion Race to the Top for College Affordability and Completion, which would give competitive grants to states working to keep college affordable. The plan, which would require states to maintain their own spending levels on higher education and smooth transfer among community colleges and public universities, among other changes, was proposed last year, but even Senate Democrats chose not to include it in their own budget plan for the 2013 fiscal year.

Obama also proposes major changes for federal work-study grants and Perkins loans, expanding Perkins loan volume to $8 billion from $1 billion and allowing more colleges access to the money, which is now distributed according to a funding formula that favors older institutions that have been in the program for many years. The money would be used to hold colleges accountable for providing “good value” -- a proposal that the president first put forward in his 2012 State of the Union address, but that has advanced little in the intervening 14 months.

But given the budget constraints, few of these new spending proposals are likely to advance through Congress, Fansmith said. “Most of the things right now that propose to spend money on new programs the appropriators just aren’t particularly interested in,” he said. “We’re going to be under the tightest caps we’ve seen in a very long time.”

Favoring Science

Even as downward pressure has mounted on federal spending generally, the administration's 2014 proposal not only would keep science and research budgets whole, but would increase many of them.

“The President’s FY2014 budget reflects the wise recognition that investing today in science, innovation, and STEM education is the best way to maintain America’s edge in the development of transformative technologies, the industries of future, and breakthrough solutions to national and global challenges,” said John P. Holdren, director of the White House Office of Science and Technology Policy. “We have seen
time and again that fueling the American R&D engine not only results in new tools to solve our toughest problems but also opens new doors to jobs and opportunities for all Americans.”

The administration would continue its efforts to significantly increase spending on the natural sciences, with the National Science Foundation seeing a boost of 8.4 percent over all (and 9.2 for its research programs), and the Energy Department's science office and the Commerce Department's National Institute of Standards and Technology benefiting from increases of 6.3 percent and 23.6 percent, respectively.

The largest funder of academic research, the National Institutes of Health, would receive $30.7 billion under the president's 2014 plan, up 2.8 percent over 2012. (Typically budget increases are shown over the previous year, but because the impact of the sequester on the recently enacted 2013 federal budget is still unclear, all of the figures released by the administration this year compared 2014 proposals to 2012 actual figures.)

The NIH budget would include funds for a new program aimed at bolstering the role of "big data" in biomedical research, including in the training of data scientists, and $50 million for a new effort aimed at dealing with the relative dearth of members of minority groups in the scientific work force.

While the administration's proposal would cut funding overall for the Pentagon, funds for basic scientific research within the Defense Department would increase, as seen in the table below.

Status of Other Programs Important to Higher Education

Beyond the Education Department and science programs, the administration's budget affects numerous other agencies and programs that affect many colleges.

• The 2014 budget plan would increase spending on the National Endowments for the Humanities and the Arts to $154.5 million each, up by about $14 million.
• Funding for the Americorps national service program would hold flat at $345 million under the president's plan.
• The administration would increase Labor Department funds for training of adult and dislocated workers by nearly 3 percent each, to $792 million and $1.27 billion, respectively.
• The State Department would cut funding for its educational and cultural exchange programs by about $30 million, with most of the decrease resulting from the elimination of an $18.5 million program of regional graduate fellowships. Funds for the Fulbright program would remain flat.
• The administration's budget plan, as it did last year, calls for reducing or eliminating several tax deductions that have implications for colleges. The most visible would reduce the value of itemized deductions for high earning Americans, which colleges and other nonprofits fear could diminish their willingness to make charitable contributions. The Obama budget would also cap the tax exemption for interest paid by municipal bonds, which could diminish the attractiveness to investors of a tool that many colleges use to finance their facilities.

The Obama Budget for Education and Labor Programs

The Obama Budget for Key Science Agencies, 2014

Doug Lederman contributed to this article.