What to do about the rising amount of student loan debt has recently taken center stage in domestic policy discussions, as the average student who completes a bachelor’s degree and takes out debt now has a student loan burden of around $30,000. Media reports love focusing on those with much larger amounts of debt—who tend to either have graduate degrees or went to colleges with high costs of attendance—but these students are a minority. The past week has seen proposals by members of Congress and President Obama to reduce the burden on those who leave college with debt. Below are summaries of the three main proposals and what they mean for students and taxpayers.
Proposal 1: President Obama’s extension of more generous income-based repayment (IBR) terms. He signed an executive order authorizing the Department of Education to enter the federal rulemaking process in order to extend IBR terms that apply to current Direct Loan borrowers retroactively for those who borrowed before 2007 or those who have not borrowed since 2011. Once approved (no sooner than 2015), borrowers could pay 10% of their discretionary income over 20 years instead of 15%. This proposal has gained support from many in the higher education community, but there are concerns about costs and whether the President has the authority to act without Congressional approval.
Proposal 2: Sen. Warren (D-MA)’s proposal to refinance student loans. She has introduced multiple proposals to lower interest rates, including one to lower rates to 0.75% (which I called “a folly”). Her most recent proposal would allow students to refinance federal and some private loans at the current subsidized Stafford loan interest rate (3.86%). President Obama endorsed the plan when he signed his executive order, but the likelihood of the plan passing is fairly low. It is expected to cost about $55 billion (a number highly dependent on how many borrowers actually refinance), and is paid for by a surtax on millionaires. While passing the Democrat-controlled Senate is possible, it is unlikely to pass the GOP-controlled House.
Proposal 3: Sen. Warner (R-VA)’s and Thune (R-SD)’s proposal to allow employers to contribute pre-tax dollars to help repay employees’ loans. This proposal came as a surprise, particularly the provision that borrowers would have to refinance in the private market before participating in the program. No cost information is currently available to the best of my knowledge, and this proposal is unlikely to pass.
While all three of these proposals could help at least some borrowers in the short run, none of them do anything to affect the main reason behind the growth in student loans: the rising cost of college. If anything, making it easier to repay loans has the potential to increase college costs as colleges’ incentives to reduce costs are decreased. This fits in with the “Bennett Hypothesis,” in which increases in federal financial aid are associated with increased costs. (Evidence to support the hypothesis is mixed.)
Making IBR programs more generous could have serious long-run implications for millions of students. Under current law, students in IBR programs (excluding those in the Public Service Loan Forgiveness program) will face a tax bill for any balance forgiven at the end of the loan (typically 10-25 years). President Obama did not mention that when signing the executive order, even though it is likely that many borrowers will face a substantial tax burden when their loan is forgiven. If a remaining balance of $30,000 is forgiven (on the low end of the likely distribution), the borrower can face a tax burden of $10,000.
The issue of the forgiveness tax has not yet reached center stage, but will do so in the next few years as the first wave of IBR borrowers begin to reach the end of the repayment period. Congress needs to clarify whether the forgiveness tax will remain in place in order to give borrowers as much information as possible. Congress can choose to eliminate the tax, but the loss of revenue must be offset elsewhere in the federal budget through spending cuts or tax increases. Or they can keep the tax, but could consider spreading out the burden over multiple years.
Thinking about the long-term implications of loan forgiveness under IBR is not sexy, and it is not a topic that will resonate with many voters at this point in time. But politicians need to consider the ticking time bomb and how to best defuse it before more Americans enroll in IBR.