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Deep Dive: Student Loan Forgiveness Part I
Why Biden's student debt plan is bad policy - economic concerns
Bias disclosure: I am currently part of a household with six figures of student debt and I work at a university that is the recipient of millions of dollars’ worth of federally-backed student loans each year.
Once a left-wing fringe theory, student debt forgiveness has since become part of the Democratic Party mainstream. By media hivemind fiat, that amount must be described at least once per article as “crushing”. Total student loan debt now equals an astonishing $1.7 trillion dollars, meaning that it has outpaced auto debt ($1.4 trillion), and is now only second to mortgages as the biggest source of American consumer debt. This is a complicated topic, so it’s been broken up into two parts. Part I contains a historical background and economic reasons student debt forgiveness is bad policy. Part II will be published tomorrow and covers ethical and efficacy concerns.
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First, how did we get here? Student debt is unique in several ways. People on both sides of the argument like to compare student debt to mortgages, car loans, etc. While in some ways they are the same in that you have a lender with extra cash matching with a borrower who needs funds, student debt differs from most other debt in a fundamental way: there is no way to repossess an asset if the borrower defaults. If you don’t pay your mortgage, guess what? The bank will foreclose on the property and evict you. That process is time consuming, but rest assured, it will happen. Fall behind on your car payments? A popular reality TV show lasted 11 seasons and over 200 episodes reenacting repo men taking cars from people who weren’t paying off their debt.
Of course student debt doesn’t work that way. Once one gains a degree, and certainly once information is learned, there is no way for a lender to recoup their investment if the borrower stops paying back the loan. Ordinarily, such a system would result in a lender requiring collateral to be put up. Alas, this won’t work because the typical college student owns nothing even close to the value of an education. If a borrower takes out a loan and gets a degree, there is no way for a lender to recoup that loan if the borrower defaults.
This creates a problem for the government. On one hand, bankruptcy is a key feature to a healthy economy (remember debtors’ prisons?). On the other, it’s hard to imagine a student loan market properly functioning if bankruptcy was an option. Especially in high-income fields, students would incur six figures of debt, graduate, and then declare bankruptcy. Sure the student has bad credit for a time, but if they have good jobs, it is worth the lack of debt. This would quickly unravel the entire market, as lenders would stop issuing student loans altogether. The result is that under the Higher Education Act of 1976 and subsequent laws, a borrower cannot default on student debt under most conditions.
With the federal government offering loans for higher education with almost no conditions, the result was entirely predictable: the price of tuition exploded. Because many universities have embraced the “always on sale” pricing model where hardly any student pays the sticker price for tuition, it is hard to determine exactly how much prices have risen, but risen they have. And why not? If you’re an organization whose customers will be able to take out loans for almost any amount, there isn’t much of an incentive to keep prices down. While it’s easy to blame this all on universities, state governments are just as culpable. Despite maintaining a significant amount of control over the operations of their local state university, they have abandoned the responsibility of paying for it. The state of Colorado, for example, only contributes an astonishing two percent of the University of Colorado Boulder’s budget. They saw the same incentive structure as private universities – if the feds are agreeing to limitless loans, why keep costs down?
That leads to the situation today. Americans currently have $1.7 trillion worth of student debt. Undoubtedly those with tens, or hundreds, or thousands of dollars’ worth of debt would be better off without it. So why is forgiveness bad policy?
First, typical student debt isn’t actually crushing. The typical (median) American with student loan debt owes less than $20,000. 50 percent of all student debt holders owing $20,000 or less is not an insurmountable sum. The median wage for a full-time worker in America is over $50,000. That’s includes both college graduates and those without a degree. Even including any America 15 years or older who received any earnings at all only drops the median income to $40,000. Again, this is not just college graduates, but any individual that received at least a dollar for work over the year. Having a debt less than 50% of the typical annual salary, let alone college-educated-wage, is not life ruining.
Of course there are individuals who owe hundreds of thousands of dollars for their education, and that pulls up the average considerably. One in every 13 borrowers owes over $100,000. One in every 50 borrowers owes over $200,000. Yet these are individuals that decided to take the most expensive path at every single juncture. Private schooling. Graduate degrees. Middle class lifestyles when still a student. These are individuals that do have large amounts of debt, and they are individuals that chose options that would allow them to live significantly more expensive lifestyles then they could afford. Thus, a one-time $10,000 forgiveness doesn’t accomplish its proponents’ stated claims. If student debt is crushing, then $10,000 worth of forgiveness isn’t going to solve the problem. If $10,000 solves the problem, then student debt isn’t crushing.
The bigger issue, however, is who this money is going to. The answer, in many cases, is those that don’t need it. Economists often describe public policy plans as progressive vs. regressive. A progressive tax means that those who have higher incomes will pay more of the tax than those who have lower incomes. A regressive tax means those who make less money pay more than those who make more money. A tax on first-class plane tickets would be progressive, a tax on subway fares would be regressive. Progressive policies benefit low income individuals, regressive policies benefit high income individuals.
Biden’s plan has two aspects. A lump forgiveness and a reduction in payments. The $10,000 forgiveness is probably slightly progressive, but could also be slightly regressive. I suspect the Biden administration knows this, which is why they’ve deployed a deceptive graph on the White House website. About halfway down the page, there is a bar graph that titled “Nearly 90% of Debt Cancellation Benefits Will Go to Borrowers Earning Less Than $75,000”. First, the actual amount is 87%. The bigger issue, though, is that $75,000 is a high salary! Again, a regressive policy is one that benefits those that make more than the median income. The median income for a full-time employee is about $50,000. We can argue about median vs. average vs. geographic differences, but if this was actually meant to be a progressive policy, the percentage of people who make substantially more than the median income who benefit should not be 13%, it should be zero.
The other, and less reported part of the plan, is a reduction in loan payments. This has some alarmingly regressive elements. Biden’s plan will “For undergraduate loans, cut in half the amount that borrowers have to pay each month from 10% to 5% of discretionary income.” The plan will also “Raise the amount of income that is considered non-discretionary income and therefore is protected from repayment, guaranteeing that no borrower earning under 225% of the federal poverty level.”
Mentioning the poverty level makes a policy sound de facto progressive, but let’s dig into the numbers. The federal poverty line is currently $13,590 for a single person. 225% of that is roughly $30,000. What does that mean for a theoretical employee? The White House website uses construction workers, teachers, and nurses as examples. It could equally apply to insurance adjusters, used car salesmen, and stockbrokers, but let’s just call them workers. Consider a worker who took out $50,000 worth of student loans. It’s now three years after graduation, and the worker has an income of $60,000 per year. Under Biden’s plan that individual would only have to pay $1,500 per year [(60,000-30,000)*.05], or $125 per month. In total, they would pay $30,000 before the rest of their loan is forgiven after 20 years, just over half of their debt, and no interest.
The worst part of this is that our hypothetical workers does not need government help. A 25 year old making $60,000 is doing well, enough to put then in the top 40% of all American workers! Of course it is likely our worker will get raises over the years and make considerably more than $60,000 by the time they qualify for the 20 year loan forgiveness. So where’s the breakeven point; that is, how much money would a worker have to make to at least pay back the principal of their loan? Under Biden’s plan, any worker who averages $80,000 over their first 20 years of employment are essentially getting an interest free loan and only paying back the principal. $80,000 puts individuals well above the median wage. Again, not people who should be the beneficiary of government largesse.
It gets worse, however, when you consider lifetime earnings of college graduates. (Some may point out that Biden’s plan forgives those who attended college, but didn’t graduate and don’t have large wage premiums. I agree that they are in a different situation, and it would be easy to address this issue with a more targeted plan.) Various studies have already shown that college graduates make substantially more over their lives then non college graduates. So even an individual with a college degree that is “only” making $40,000 today will likely make substantially more than the typical American over the course of their lifetime.
A lot of the discourse around the student debt forgiveness has muddled the difference between forgiving excess interest and merely paying off the principal. One strong argument in support of student debt forgiveness is that it can be unclear to a teenager how interest compounds and how long it will take to pay off a debt. One could argue America’s youth are being taken advantage of if they are signing up for loans when they don’t understand how interest rates work. It’s a much harder argument, however, to say that a high school senior can’t understand how the principal works. It’s just common sense that if a student plans to borrow $40,000 a year for a four year program, they will owe at least $160,000 when they graduate. This is obvious. A forgiveness plan that was truly interested in righting any (perceived) wrongs would differentiate between principal and interest. Biden’s plan does not.
One aspect of the student loan forgiveness that has drawn too much attention from critics are the possible inflationary impacts. Although loan forgiveness is bad policy, it will be mildly inflationary at worst. The US government pumped $5 trillion dollars income the economy over a two year period – another couple hundred billion may be slightly inflationary, but probably only a one to two tenths of a percent. Not helpful given how fast prices have risen in the US over the last two years, but not a major concern.
Taken in full, when considering who is benefiting from the $10,000 forgiveness, and especially the halving of the income-driven repayment amounts, this does not make economic sense. Will it help those who qualify? Of course. Any government welfare program will have beneficiaries. But this money is coming from taxpayers and ultimately a lot of it is going to those that do not need it.