As part of the legislative process, the Congressional Budget Office provides Congress with cost estimates for legislation, economic and budget projections, and other economic assessments. Information from the research community is an important element of CBO’s analyses. This is the second in a series of blog posts looking at research that would improve the quality of information the CBO uses in its work. (The first post in the series discussed the need for new research on energy and environment.) Send your comments to communications@cbo.gov.
The CBO regularly provides information to Congress on the effects of proposed policies that would modify federal credit and insurance programs. The agency is looking for new research related to various topics in the area of finance, including student loans and pension insurance. CBO is currently working on those issues, and there are significant gaps in the relevant research literature.
The cost of the federal student loan program depends in part on how borrowers respond to changes in their repayment plans. Following the expansion of income-defined repayment (IDR) plans, which began in 2009, CBO estimates of the cost of the program initially tended to underestimate the number of borrowers who would use those plans and the degree to which borrowers would adversely select plans. with high balances and low income. Furthermore, estimates of repayment rates would have benefited from empirical studies examining specific segments of the heterogeneous population of borrowers that would be affected by such policies, or by anticipating the potential impact of proposed policies. A recent study provides a survey of the student loan literature (Yannelis and Tracey 2022).
CBO recently estimated the cost of a new IDR plan proposed in January 2023 (CBO 2023). Due to the reduced borrowing costs of the new plan, CBO expected it to be the most popular repayment plan option and that the amounts borrowed would increase with the plan.
The government provides pension insurance for single-employer and multi-employer pension plans, both of which have experienced funding difficulties over the past two decades. The effects of legislation addressing these difficulties would depend on how policy changes affect the likelihood of employer pension and withdrawal plan freezes, as well as the solvency of plan sponsors (employers), among other factors. Cash flows for pension insurance are tracked in the federal budget: claims are recorded as disbursements when paid; premiums are recorded as compensation receipts when received. The CBO and the staff of the Joint Committee on Taxation are tasked with analyzing the budgetary implications of federal policies affecting contribution requirements, premium payments, investment restrictions, and other pension-related funding rules. Research showing how employers would react to and be financially affected by such policies would enhance CBO’s analysis.
How would borrowers respond to major changes in student loan repayment plans?
CBO used its microsimulation model of student borrowers (Karamcheva, Perry and Yannelis 2020) to estimate additional enrollment in IDR plans. In preparing that estimate, the agency found no research that was directly relevant to estimating the amount of additional borrowing that might be induced by the availability of the more generous repayment plan. CBO expected additional lending to occur on the extensive margin (among those who were not expected to borrow but were induced to do so) and the intensive margin (among those who would borrow larger amounts because a more generous repayment plan was available). .
Although some studies have examined the effects of expanding the availability of student loans (Black, Turner and Denning 2023; Kelchen 2019) and increasing debt limits (Kargar and Mann 2023; Lucca, Nadauld and Shen 2019), there was no relevant research examining how changes in lending parameters, and IDR parameters in particular, would affect students’ propensity to borrow and the amounts they borrow. Research in that area could help inform the CBO’s baseline projections for student loans over the next 10 years and, in turn, its projections for the cost of the student loan program.
How would pension plan sponsors respond to changes in government pension insurance?
Over the past 25 years, large employers have reduced the use of defined benefit pension plans through plan freezes that stop benefit accrual for all workers or close plans to new hires. One study found that freezing pension plans saves 13.5 percent of the present value of payroll in the long run (Rauh, Stefanescu and Zeldes 2020). Additional research identifying the factors likely to lead to plan freezes, as well as the conditions that encourage plan sponsors to retain defined benefit pension plans, would help the CBO better estimate the effects of the legislative proposals. that would change the government’s policy on pension insurance. For example, proposals that would increase the number of plan freezes could reduce premium receipts for pension insurance provided by the federal government.
Similarly, little research is available on the incentives for participating employers to withdraw from multiemployer pension plans, either individually in a partial withdrawal or collectively in a mass withdrawal. The CBO model has focused on mass withdrawals because they have been more closely related to insurance claims and financial data on participating employers is sparse (Kiska, Levine and Moore 2017). However, partial withdrawals have significantly affected the funding level of the plan and often put financial pressure on employers who remain in the plans. Legislation may affect incentives to leave, and further research into the factors that encourage employers to stay in or withdraw from pension plans would help the CBO better estimate participation (which affects premium receipts) and the future financial results of the plans (which affect future federal outlays) .
Funding of single-employer and multi-employer pension plans is sensitive to price volatility in financial markets where pension assets are invested in risky securities. In addition, federal insurance for private pension plans can encourage risk taking. For example, a study has found that low-priced pension insurance encourages plan sponsors to invest in risky assets (Love, Smith and Wilcox 2011). Additional research on the factors that influence how plan administrators manage risk in response to both the price and level of federal insurance would help the CBO estimate future government outlays. When legislators consider pension reforms, they may also be interested in the optimal structure and pricing of pension insurance, as well as its relationship to investment policy.
Sebastien Gay is CBO’s Director of Financial Analysis. This blog post includes contributions from the following CBO staff: Scott Craver, Justin Humphrey, Nadia Karamcheva, Wendy Kiska, Jeffrey Kling, Noah Meyerson, Jeffrey Perry (formerly CBO), and Emily Stern.
