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Is Student Debt Forgiveness Worth the Money?


komal sri-kumar, an economist who heads Sri-Kumar Global Strategies, is a senior fellow at the Milken Institute.

Published August 29, 2022


President Biden’s student loan forgiveness plan announced last week no doubt warmed the hearts of millions. But not everyone is happy. Indeed, the plan raises some thorny practical and philosophical issues, which explains why it divides liberals as well as conservatives.

The Good News

In campaigning for the presidency in 2020, Joe Biden promised to write off $10,000 of debt for millions of Americans who borrowed to go to school. And now, after a fair amount of dithering, the President has made good on his vow. Student debts of up to $10,000 owed to the federal government — the largest source of student credit by far — will be written off for individuals earning less than $125,000 and married couples earning less than $250,000. Past recipients of Pell grants, the tuition subsidies limited to low-income families, will be eligible for double the loan forgiveness — up to $20,000. All told, some 40 million Americans will shed some student debt, with an estimated 15 million of them emerging debt-free.

There’s more. Loan repayments that had been scheduled to resume September 1 after a two- year pause for Covid-19 will be further delayed through the end of the year, with no interest accruing in the interim. Further alleviating debtors’ travails, those who borrow for college will get to cap annual debt payments at 5 percent of discretionary income, which is more or less defined as income for a one-earner household minus $30,000. And those who borrowed $12,000 or less, which includes most who borrowed for community college, will have their remaining debt wiped off the books after 10 years of payments. 

One goal is to give younger debtors a shot at diverting the savings into first-time home purchases. Supporters of the Biden plan also point out that the measure would reduce racial disparities that dog a higher-education system so dependent on debt finance. Some two million Black debtors will become totally debt-free as a result of President Biden’s decision.

The Bad News

What could be wrong with such a well-intentioned policy? For starters, the timing is unfortunate: it comes after $900 billion in fiscal spending in the final months of the Trump administration intended to fight Covid-19, followed by another $1.9 trillion in the Biden program during the first year of his administration. Canceling this big chunk of student debt will add about $600 billion to the federal debt over a decade, feeding inflationary forces in an economy that can ill-afford the stimulus.

Second, President Biden has tempted Democrats to press for more. Influential senators, including Elizabeth Warren and Chuck Schumer, have suggested that the write off be increased to $50,000 per debtor, with correspondingly larger fiscal implications.

Keep in mind that easy access to student debt gave colleges and universities an easy path to raising tuition — which they’ve done with a vengeance in the past few decades even as state legislatures have starved their education systems.

Third is an issue of fairness that cuts across ideological lines. While some three-quarters of the benefit will go to households with incomes below $88,000, there will be no reward for those who either took on no debt, or completely paid it off. This argument, by the way, may get more traction than you might expect. After all, the issue that set the Tea Party and the MAGA-vores on the warpath was the alleged unfairness of bailing home buyers who couldn’t make their mortgage payments during the Great Recession.

The View from 40,000 Feet

First, don’t expect much joy for first-time home buyers from debt forgiveness. Housing affordability — a measure comparing mortgage payments to income — is at its lowest level since 2006 due to sharp increases in home prices and mortgage rates over the past year. Not having to pay back $10,000 to $20,000 in federal loans is unlikely to significantly boost the ability of first-time home buyers to get mortgages. Furthermore, despite the reduction in debt, students and former students will still collectively owe $1 trillion, limiting their spending capacity. On the other hand, the rent-paying capacity of those who get debt relief may improve modestly, further aggravating increases in rent that have been a key factor in boosting consumer prices. Expect this to worsen the hardship of those who never contracted a federal loan in the first place.

Second, keep in mind that easy access to student debt gave colleges and universities an easy path to raising tuition — which they’ve done with a vengeance in the past few decades even as state legislatures have starved their education systems. And since the Biden measures pose no new restrictions on tuition charged by universities, the reduction in student debt will only encourage educational institutions to keep the credit wheel spinning. 

If the government did want to provide debt relief, could it have been handled better? Yes, by having forgiveness not be a stand-alone initiative but a sweetener in a comprehensive plan to contain the escalating cost of higher education. I do not mean price controls, but using financial incentives to push universities back to the plain-vanilla task of education. For example, the earnings of college endowments are currently tax-exempt, with no stipulation that the funds be used solely to educate the neediest individuals.

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Higher education is, in part, a “public good” — America needs to invest in more graduates who have skills in demand for the changing economy. But forgiving tuition-related debt without simultaneously raising the productivity of the education system is, at best, an inefficient means toward that end — and more likely, self-defeating.

main topic: Fiscal Policy