Three Questions About Student Debt Forgiveness

President Biden’s proposal to forgive the student debt of up to 40 million Americans has proven to be very controversial. Some have applauded it as a bold move; others see it as a poorly thought-out move, setting a reckless and costly precedent. Perhaps one way to determine which perspective is more likely accurate is to consider the answer to three questions that are relevant for any policy proposal: What is the rationale for this policy choice? Who will benefit and who will pay? And what might be the unintended consequences?

Rationale for the Policy

The stated rationale for the policy is to ease the burden of individuals, primarily younger individuals, who are saddled with unmanageable student debt and are forced to delay other elements of adulthood, including home ownership and starting a family. However, one might ask why this special focus on the burden of student debt as opposed to other forms of debt? Newspapers are rife with stories of families unable to service mortgage debt, automobile debt or medical debt, and therefore facing foreclosure, repossession of a car, loss of livelihood, and even bankruptcy. Delinquency and default in any of these categories of debt, and certainly bankruptcy, blight one’s future. However, the federal government generally has not supported widespread debt forgiveness for these classes of debt, even during times of crises. Additionally, individuals who take on student debt are thought to have received something of great value in return, namely, a college education. Economists estimate that the return on a college degree is hundreds of thousands of dollars, which more than offsets the average debt burden of $30,000. Given these background facts, what explains the national focus on the student debt burden? It likely reflects the confluence of three factors: the size of the outstanding student debt burden—which is the largest single category of individual debt; the pace with which this debt has grown—having grown from $0.5 trillion in 2006 to currently $1.7 trillion; and the fact that student debt is associated for many people with the extraordinarily rapid rise in the cost of a college education. Additionally, the vision of student debt paying for a college degree must confront the reality that the four-year college completion rate is only around 60 percent (and much lower for disadvantaged minorities). Even when we consider those who move from four-year bachelor’s degree programs to two-year associate’s degrees, analysts estimate that more than one-quarter of those who start college drop out with no credentials. Therefore, much of student debt is held by individuals who either did not complete college or had borrowed to train for vocational jobs in which the compensation would not allow for repayment of debt during a reasonable working life. Finally, the average size of a defaulted loan is under $10,000, suggesting the dire financial lives for those for whom student debt forgiveness is most relevant. For these reasons, it might well be a reasonable policy choice to forgive the student debt of a select group of the most-needy borrowers. This leads directly to the second policy question.

Who Benefits and Who Pays

 The Biden program will forgive $10,000 of debt for individuals earning less than $125,000 income (and $250,000 income for a married couple) in the 2020 or 2021 tax years, and $20,000 for recipients of Pell grants. Analysts estimate that as many as 40 million individuals will benefit, with 20 million people having their debt fully wiped out. The estimated cost of this one-time program is between $300 and $500 billion. Since there is no provision for a special funding mechanism, all taxpayers will bear the brunt of this federal budget expense. Put another way, 320 million Americans are providing a benefit to 40 million Americans. In this regard, critics have argued that, even if the Biden forgiveness program is a reasonable policy choice, it is overly broad. The $125,000 upper limit on individual income (and double for a couple) seems particularly generous when one realizes that some potentially lucrative professions, such as law, accounting, medicine, consulting, in many cities have starting salaries that fall below that level. Additionally, having had a Pell Grant as a college student does not necessarily correlate with having chosen a low-paying career. The fact that loans incurred before July 2022 are eligible under the Biden plan means that many current students and recent graduates will benefit, regardless of their long-term potential to pay their debts fully. The result of having a $125,000 income cutoff is that roughly 30 percent of the benefit accrues to borrowers in the bottom 40 percent of the income distribution and the remaining 70 percent going to those in the top 60 percent. Certainly, a more modest income cutoff, perhaps $62,500 for individuals and $125,000 per family, would have made the policy more targeted to those who are most in need. Additionally, the fact that this is a one-time forgiveness leaves almost all observers deeply dissatisfied. Individuals graduating just a few years apart, but otherwise similar, will face very different prospects. Overall, even if one were to conclude that a student debt forgiveness is an acceptable policy choice, the answer to the second question of who pays and who benefits is still troubling for many observers. Given this, much depends on the third question of unintended consequences.

Unintended Consequences

The debate regarding unintended consequences has centered on the question of whether this program adds to inflationary pressures at a time when inflation is already running well above the Federal Reserve’s 2 percent target. The Biden proposal of debt forgiveness is paired with a resumption of student debt payments in January 2023, after a two-year pause. The consensus of most, but certainly not all, analysts is that the impact of forgiveness on inflation is likely to be offset by most borrowers resuming payments when the student loan pause ends in January. Not surprisingly, those analysts who calculate the potential inflation find some modest impact, a 0.2-0.3 percent increase in inflation, if student debt forgiveness did not occur at all. Critically, all these estimates depend on assumptions of the proportion of eligible individuals who successfully have their debt forgiven and those who comply fully with the initiation of repayment in January. Clearly, this is unknowable currently. However, there is an additional uncertainty. Debt is part of household wealth, while repayments influence cash flow. Economists have only an incomplete understanding of how an increase in wealth from forgiveness of debt will impact consumption. The “wealth effect” from an extra dollar of housing wealth is estimated at roughly 4 percent. Additionally, surveys related to student debt forgiveness suggest a frugal mindset among federal student loan borrowers. More than half of those surveyed, 53 percent, indicate that they would use the extra money to pay off other loans; 45 precent indicate that they would save for retirement; and 41 percent would invest the money.

Conclusion

Overall, one might argue that a student loan forgiveness might well be a reasonable policy position. However, the Biden program might be overly generous, particularly given the strongest argument for such a program is to help the neediest. Finally, while very capable analysts have argued that there is an increased risk of inflation, the most troubling estimates are relatively small given the magnitude of the inflation challenge and there are some reasons to believe that much of the extra cash will further reduce financial stress. Most importantly, the fundamental weaknesses of the American higher education system—low completion rate, dependence on loans, and rapidly increasing college costs—still need to be addressed.