Joe Biden isn’t making anyone happy lately when it comes to student loans.
The administration sought to strike a balance last month when it announced that it was extending the Covid-related moratorium on federal student loan repayments. But the move was criticized by both moderates, who see the moratorium as unnecessary and regressive, and progressives, who think it does not go far enough and want to see outright loan forgiveness.
However, this debate misses the true nature of the student loan debt problem. What really matters is not the total amount owed by any borrower, but the amount of the monthly payment relative to the borrower’s income. Large debts owed by high-income borrowers are often affordable, while smaller debts of those who do not complete college or attend predatory for-profit schools can pose crushing hardships.
There is no question that for a large and growing number of borrowers, student loan debt is unaffordable. Twenty years ago, the amount of student loan debt was so small that the Federal Reserve Board did not even maintain statistics on it. Today, it is the largest body of consumer debt following mortgages, even though it is concentrated among a smaller share of the population. Student loan debt is starting to have negative macroeconomic effects, including by delaying debtors’ entry into the homeownership market and dissuading Americans from pursuing education.
So some measure of student loan debt relief is clearly warranted. The question is how best to do it.
Proposals to forgive some amount of student loans across the board — whether the $10,000 the president has suggested or the $50,000 urged by some Democratic members of Congress or all of it, as some borrower advocates would like — are problematic for legal, economic and political reasons.
Legally, the president’s authority to forgive any amount of student loans on a blanket basis is uncertain. While there are serious legal arguments that the education secretary has that authority, such an action could be considered unauthorized spending by the administration, particularly by a hostile Supreme Court.
Economically, across-the-board loan forgiveness raises serious fairness concerns, both among existing borrowers and vis-a-vis future borrowers. Blanket loan forgiveness does not distinguish between borrowers who can easily repay their loans and those who cannot.
Blanket relief could end up routing too much relief to those who do not need it and too little to those who do.
A Harvard graduate pulling in half a million dollars on Wall Street will get the same relief as a community college graduate working as a barista. That could fuel a sharp political backlash, with Republicans all too happy to argue Democrats are bailing out young elites.
Blanket relief could also seem unfair to former and future borrowers. Those who scraped by to pay off their loans last year may feel like suckers for having done the responsible thing, while those just entering school will be facing even larger debt burdens, but without the prospect of loan forgiveness at any time in the near future because the political pressure to do so will have been relieved by a one-off forgiveness event. While some forgiveness could be justified because of the failures of the loan system, it would leave some of the biggest problems unsolved.
Going forward, there’s a better and fairer way of helping student borrowers: Let them make payments based on their income level.
Federal student loans currently allow almost all borrowers to opt into income-driven repayment (IDR) plans. These plans cap the borrower’s annual payment as a percentage of the borrower’s income reported on tax returns to the IRS, much like the Affordable Care Act does for health insurance premiums. The borrower pays only an affordable amount for 20 or 25 years under these plans, after which any remaining amount is forgiven. Thus, under an IDR plan, the borrower’s total debt is largely irrelevant because much of it will eventually be forgiven.
The problem is that under the current student loan system, IDR is not the default repayment plan for borrowers. Instead, borrowers need to take affirmative steps to enroll in IDR and then need to recertify their eligibility every year. Many borrowers are unaware of IDR options and federal loan servicers are not incentivized to ensure that borrowers know about their choices. Even those borrowers who are aware of IDR options often fail to stay on top of their annual paperwork. And it’s difficult for borrowers in default to get into IDR, even though they need it the most. As a result, hundreds of thousands of borrowers who should be in IDR are not and end up with massively larger — and often unaffordable — student loan payments.
Congress could readily fix this problem: provide that repayment of all federal Direct Loans be done on an IDR plan and direct the IRS to share the tax returns of all federal Direct Loan borrowers with Federal Student Aid and its loan servicers. Alternatively, by shifting all borrowers to IDR, Congress could simply have student loan repayments collected through tax withholding, as is done successfully in other countries like Australia and the United Kingdom.
Getting Congress to do just about anything is difficult, but there’s been bipartisan support for IDR reforms in the past. For example, the first major expansion of IDR happened under the George W. Bush administration.
Income-driven repayment is not a perfect system, and other reforms are needed for it to fulfill its promise of affordable student loans, including ensuring that borrowers are not taxed on amounts forgiven. Moreover, IDR is not the right solution for those borrowers who have already been making payments for decades; these borrowers need some measure of immediate forgiveness. But some of these changes are in the works and could easily be part of a larger overhaul that makes IDR the default — or even the only — repayment plan.
Moving to a system where all borrowers are in reformed IDR plans would ensure that everyone pays what they are able to pay. The Harvard graduate banker would have to repay more than the community college-grad barista. A universal IDR system would also ensure generational fairness. It would benefit not only current borrowers, but also future borrowers, ensuring once and for all that student loans cease to be a looming economic policy problem.
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