A Call for New Research in the Area of Finance

Posted by
Sebastien Gay
July 18, 2023

As part of the legislative process, the Congressional Budget Office supplies the 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 discussing research that would enhance the quality of the information that CBO uses in its work. (The first post in the series discussed the need for new research on energy and the environment.) Please send comments to communications@cbo.gov.

CBO regularly provides information to the Congress about the effects of proposed policies that would modify federal credit and insurance programs. The agency is on the lookout for new research related to various topics in the area of finance, including student loans and pension insurance. CBO is currently working on those topics, 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-driven repayment (IDR) plans, which began in 2009, CBO’s estimates of the program’s cost initially tended to underestimate the number of borrowers that would use those plans and the degree to which the plans would be adversely selected by borrowers 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 the proposed policies. One recent study provides a survey of the literature on student lending (Yannelis and Tracey 2022).

CBO recently estimated the cost of a new IDR plan proposed in January 2023 (CBO 2023). Because of the new plan’s reduced borrowing costs, CBO expected it to be the most popular repayment plan option and that amounts borrowed would increase under the plan.

The government provides pension insurance for single-employer and multiemployer pension plans, both of which have experienced funding difficulties in the past two decades. The effects of legislation addressing those difficulties would depend on how changes in policy affected the likelihood of pension plan freezes and employer withdrawals, as well as the solvency of plans’ sponsors (employers), among other factors. Cash flows for pension insurance are tracked in the federal budget: Claims are recorded as outlays when paid; premiums are recorded as offsetting collections when received. CBO and the staff of the Joint Committee on Taxation are tasked with analyzing the budgetary implications of federal policies that affect contribution requirements, premium payments, investment restrictions, and other funding rules related to pensions. Research that demonstrates how employers would react to, and be financially affected by, those policies would enhance CBO’s analyses.

How Would Borrowers Respond to Major Changes in Repayment Plans for Student Loans?

CBO used its microsimulation model of student borrowers (Karamcheva, Perry, and Yannelis 2020) to estimate the additional enrollment in IDR plans. When preparing that estimate, the agency did not find research that was directly relevant to estimating the amount of additional borrowing that could be induced by the availability of the more generous repayment plan. CBO expected that additional borrowing would occur on the extensive margin (among those who were not expected to borrow but were induced to borrow) and the intensive margin (among those who would borrow greater amounts because a more generous repayment plan was available).

Although some studies had examined the effects of expanding the availability of student loan credit (Black, Turner, and Denning 2023; Kelchen 2019) and increasing borrowing limits (Kargar and Mann 2023; Lucca, Nadauld, and Shen 2019), there was no relevant research examining how changes in loan parameters—and in parameters of IDR plans in particular—would affect students’ propensity to borrow and the amounts they borrow. Research in that area could help inform CBO’s baseline projections of student borrowing over the next 10 years and, in turn, its projections of the cost of the student loan program.

How Would Sponsors of Pension Plans Respond to Changes in Government Pension Insurance?

Over the past 25 years, large employers have reduced their use of defined benefit pension plans through plan freezes that stop benefit accruals for all workers or that close the 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 that identifies the factors that are likely to lead to plan freezes, as well as the conditions that encourage plans’ sponsors to retain defined-benefit pension plans, would help CBO better estimate the effects of 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. CBO’s modeling has focused on mass withdrawals because they have been most closely related to insurance claims, and financial data on participating employers are scarce (Kiska, Levine, and Moore 2017). However, partial withdrawals have significantly affected the level of plan funding and often impose financial strain on the employers remaining in the plans. Legislation may affect incentives to withdraw, and additional research on the factors that encourage employers to remain in or withdraw from pension plans would help CBO to better estimate participation (which affects premium receipts) and plans’ future financial outcomes (which affect future federal outlays).

Funding for both single-employer and multiemployer pension plans is sensitive to price volatility in financial markets in which pension assets are invested in risky securities. Moreover, federal insurance for private pension plans may encourage risk-taking. For example, one study has found that underpricing pension insurance encourages plans’ 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 pricing and the level of federal insurance would help CBO estimate the government’s future outlays. When lawmakers consider pension reforms, they may also be interested in the optimal pricing and structure of pension insurance, as well as its relationship with 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 of CBO), and Emily Stern.