NAICU Washington Update

President’s Budget Proposes Market-Based Interest Rates on Student Loans

April 15, 2013

President Obama sent his FY 2014 budget request to Congress on April 10. While the budget offers olive branches to Republicans with respect to entitlement reform, including both Social Security and Medicare, his proposals for student aid are among those areas sparking a heated debate.  Front and center is the administration’s proposal to switch to a market-based interest rate - with no cap on how high that rate could be - for all student loans.  As a counterbalance, the plan would also offer an expanded and more generous income-based repayment option for student borrowers, although there would be no such relief for parents who borrow with high-rate loans.  The President also repeated his call for a cap on tax deductions, including those for charitable contributions.

Interest Rates 

The impetus for proposing changes to the student loan program is the interest rate increase - from 3.4 percent to 6.8 percent, scheduled to go into effect for subsidized student loans on July 1. The student loan interest rate has been a political hot potato since Rep. Nancy Pelosi (D-Calif.) included a plan to cut it by half, from 6.8 percent to 3.4 percent, in her “Six for ‘06” campaign that helped Democrats gain control of the House in 2006. Last year, the issue again drew attention in the presidential race, when Mitt Romney (R-Mass.) supported a $5 billion, one-year fix to keep interest rates at 3.4 percent, preventing those loan rates from becoming a presidential campaign issue. Students remain opposed to the increase to 6.8 percent, but seem to be hinting some support for the market-based rate since, in the short term, current low interest rates would make loans cheaper for all borrowers.

Currently, student loan interest rates are set by statute rather than determined by market conditions; that’s why those rates have been as high as 6.8 percent during a time when market rates are far lower. The President’s plan provides that the interest rates on new student loans each year be set according to a market-based formula. The formula would be pegged to the 10-year Treasury bill rate, with a percentage add-on based upon the type of loan: an additional 0.93 percent for subsidized Stafford loans, 2.93 percent for unsubsidized loans, and 3.93 percent for PLUS loans. That market-based rate would be set when the loan is initiated and it would remain fixed for the life of the loan. However, a controversial element of this plan is that it would not set a cap on how high the market-based rate could go. Additionally, the proposal would eliminate the current 8.25 percent cap on consolidation loans. Not capping rates is a major change to a program that has always had rate caps on federal student loans in the past.

As a trade-off to eliminating caps on interest rates, the administration also proposes extending “Pay as You Earn,” one of three Department of Education income-based repayment (IBR) programs, to all student borrowers. “Pay as You Earn” caps monthly repayment at 10 percent of discretionary income, and forgives the remaining loan after 20 years of repayment, thus lessening the impact of high interest rates.

The federal government currently shows a net $35 billion return on student loans. A small portion of that amount goes toward the mandatory add-on to the Pell Grant maximum, but the rest goes toward deficit reduction. It is predicted that loans under the President’s proposed interest rate plan would generate $4.76 billion less than the current program, but still show a $26.3 billion “profit” for the government.

When the President’s proposal is considered on Capitol Hill, the House and Senate education and budget committees will have plenty of input into how to address the July 1 interest rate hike. Additionally, the Congressional Budget Office will probably have differing cost and savings assumptions that have to be balanced before any legislation can be enacted.

Higher Ed Reform 

There are no surprises in the FY 2014 budget request for other student aid programs, since most of the proposals are similar to last year’s. (See earlier Washington Update story.) The budget requests the scheduled increase in the Pell Grant maximum to $5,785 for the 2014-15 award year, and assumes level funding for Supplemental Educational Opportunity Grants (SEOG), TRIO, GEAR UP, graduate education, and Strengthening Institutions (Title III) programs. Federal Work Study is increased by $150 million, and Perkins Loans are slated for an $8.5 billion expansion through a redesign as a supplemental, unsubsidized direct loan.

As it did last year, the administration proposes to redistribute campus-based aid based upon institutions’ success in keeping prices low, enrolling and graduating high numbers of Pell-eligible students, and providing good value. A similar plan to reform the Perkins Loan program was unsuccessfully floated four years ago. However, despite opposition to any expansion of the Perkins Loan program, and the fact such a broad redistribution reform previously has not been proposed in this Congress, the President’s proposal could get more attention this year as conversations on reauthorization of the Higher Education Act get underway.

Other higher education proposals include 1) a $1 billion Race to the Top fund for competitive state grants “to drive higher education reform and contain tuition” (targeted at public colleges), 2) $260 million for First In the World competitive grants for “cutting edge innovations that decrease college costs and boost graduation rates” (targeted at private colleges), and 3) an $8 billion Community College to Career fund for state, community college, and employer partnerships. The budget also proposes to eliminate TEACH Grants, and replace them with grants for Presidential Teaching Fellows.

Charitable Deduction Limitation

A plan to limit the value of the charitable deduction shows up in the President’s budget again this year. The proposal would limit the tax benefit of deductions, including the charitable deduction, to 28 percent for single taxpayers earning more than $200,000 and for married/joint filers earning more than $250,000 annually. Each annual budget plan since 2009 has included this proposal, but it has never been acted on by either the House or the Senate.

While the White House estimates that the deduction limit would raise $321 billion in revenue over the next ten years, the nonprofit community decries the billions of dollars in lost donations it would create. The House Ways and Means Committee, which is looking at all current tax benefits for possible reform or restructure, held a hearing in February specifically to discuss charitable tax benefits. The hearing gave the charitable community, including college and university representatives, an opportunity to advocate for maintaining the charitable deduction without caps or dollar limitations. 


For more information, contact:


Stephanie Giesecke, (overall budget questions)
Maureen Budetti, (student aid)
Karin Johns, (tax)