The Consequences of Forgiving $1.5 Trillion in Student Loans

Senator and Presidential hopeful Elizabeth Warren (D, MA) recently proposed a policy to cancel student loan debt.

She wants to cancel up to $50,000 of debt for borrowers with annual household incomes under $250,00, including full cancellation for households with incomes under $100,000. It would be financed with an “Ultra-Millionaire Tax” – a massive redistribution of wealth from America’s 75,000 wealthiest families to 42 million Americans, many of whom have successful careers and enjoy a fruitful middle-class lifestyle.

Warren is billing the policy as the solution to an emerging student loan debt crisis that is preventing millions of Americans from completing college, buying homes, and starting businesses; thereby thwarting economic progress. But is there a crisis?

According to data from the New York Federal Reserve (NYFR), total student loan debt reached $1.5 trillion by the end of 2018. This amounts to an average loan balance of around $33,000. Although starting one’s career deep in debt may seem daunting, most economic research suggests that a college education still yields, on average, a positive return on investment in terms of increased lifetime earnings.

If students experience long-term financial benefits from going to college, despite accruing debt to finance the rapidly growing cost of higher education, this hardly suggests that rising student loan debt is a crisis. There are, however, some caveats.

[Ten Things Destroying Higher Education]

First, there is considerable variation in debt loads. As of the end of 2017, 63.2% of borrowers had student loan balances under $25,000, and 82.4% owed less than $50,000. However, 11.8% had balances between $50,000 and $100,000 and 5.7% owed more than $100,000. Many high balance debtors either attended expensive private institutions or completed professional graduate programs, so they are still likely to earn a positive return on their investment. But some of these debtors are drowning in excessive debt with little prospect of getting their heads above water.

Next, the economic benefits of college are largely associated with degree completion. Nationwide, nearly 40% of full-time students at four-year colleges fail to graduate within six years, according to the National Center for Education Statistics. Many of these students accrue substantial student loan debt but do not reap the increased earnings associated with earning a degree.

Additionally, many graduates major in fields or attend schools offering dismal career prospects. According to the NYFR, roughly one-third of college graduates are underemployed – working in jobs that typically do not require a college degree.

We recognize excessive debt, high dropout rates, and underemployment of graduates as significant social issues. These problems, however, are largely the result of unintended consequences from government policies designed to increase the number of people going to college, in the first place.

[Five Reasons Why Student Loans Are a Looming Disaster]

Particularly culpable is the federal student loan program, which was originally intended to improve access to college among students facing financial constraints. In 1987, Education Secretary William Bennett famously predicted that increases in federal student aid would drive up tuition.

According to the College Board, inflation-adjusted federal student lending increased from $45.8 billion in 1997-98 to $93.9 billion in 2017-2018, an annual growth rate of 3.7%. Over this period, real tuition and room and board fees at private and public four-year colleges grew annually by 2.4% and 3.1%, respectively. In other words, there has been significant growth in both federal student lending and tuition fees over the past two decades. But this merely reflects correlation, not causation

Andrew Gillen provides a theoretical framework explaining how government loans increase the ability for students to pay for college, which in turn is captured as additional revenue by colleges, leading to higher costs. A 2017 paper provides causal empirical evidence linking the growth in federal student lending to increased tuition.

To the extent that growing student debt is a crisis, the root of the problem is federal student loans for all policy. It has not only fueled significant increases in the cost of college but also encouraged a growing number of academically underprepared students to take on debt to attend college. High dropout rates and underemployment of college graduates provide evidence of this. As economists Richard Vedder and Bryan Caplan suggested in recent books, public policy may be encouraging too many people to attend college who are unlikely to graduate and realize its economic benefits.

[The $1.5 Trillion Student Loan Debacle Has a Tipping Point]

Christine Emba recently defended Warren’s student loan cancellation idea, suggesting that the biblical institution of jubilee provides a Judeo-Christian justification for this misguided policy idea. She notes that “during jubilee years all debts were to be forgiven and prisoners freed. It was a periodic remission that allowed families to extract themselves from the burden of unpayable debts, an acknowledgment that nothing belongs to anyone permanently, and a reminder that a society cannot survive without a certain amount of forbearance.”

Theologian Art Linsey describes that, during Jubilee, outstanding debt balances were zeroed out – there was no redistribution of wealth. Jubilee protects permanent ownership by allowing the land to remain with the family. Jubilee was not an institutionalized period of mass debt cancellation to be financed by the rich, but rather a celebration of debt being fully repaid.

Taxpayer-funded cancellation of student loans is certainly not supported with this understanding of the jubilee tradition. It is also bad economics. A taxpayer-funded bailout of student loan debt would neither address the underlying cause of ballooning debt nor impose any accountability on colleges that have allowed their students to accrue large debts without preparing them to lead productive lives. It also fails to help students find a college and major that is right for them and graduate on time.

A better long-term policy would be to get the government out of the student loan business altogether. Student loans should also be made dischargeable in bankruptcy like other forms of debt, but colleges and universities should have some skin in the game and be held at least partially accountable for the losses from loans gone sour – not taxpayers. In the short-run, there already exists an income-based repayment plan to help those struggling to earn enough to make ends meet.

While Warren’s debt cancellation idea is bad economics, it may turn out to be brilliant politics. It will provide a very large incentive for 42 million debt-holding voters, who may view the prospect of a government bailout as manna from beltline heaven, to support Warren’s Presidential campaign.

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4 thoughts on “The Consequences of Forgiving $1.5 Trillion in Student Loans

  1. There could be a substantial benefit to the federal fisc from Warren’s loan cancellation program. The amount of cancelled debt is taxable income to the debtor. If $1.5 trillion in debt is cancelled, that’s $1.5 trillion in taxable income. If the average tax rate is only 10%, that would be $150 billion in extra revenues for the federal government.

  2. This mess is a result of one of the many idiotic policy decisions during LBJ’s “Great Society” years — the subsidization of higher education through grants and loans. It may have seemed like a good idea at the time (but should have been stopped on constitutional grounds, as there is no constitutional authority for the federal government to do anything regarding education), but it has had enormous unanticipated consequences. Rather than forgiving student debts, the focus ought to be on ending federal financing of higher education altogether.

  3. How about the banks (lenders) take a big fat haircut, and we tax the universities as well. Both of these parties are very sophisticated and knew exactly what was going on, in a way that few 18-year olds understood when they signed the dotted line.

    As for Gen X being grumpy because they paid their loans, oh well. The tuition millennials are paying is double or triple what X’ers paid, adjusted for inflation. And X’s had a better job market (less competition from immigrants, less offshoring, less automation, fewer quotas and AA hiring decisions) and had lower overall cost of living. So it was easier for them to pay their loans.

  4. “there already exists an income-based repayment plan to help those struggling to earn enough to make ends meet.”

    It should be noted that these plans are relatively new, along with the related one benefiting those engaged in public sector employment. Only Millennials have been able to benefit — Gen Xers had to repay their loans…

    Most of the horror stories that people think of involve the loans of those who attended college in the 80’s, 90’s, & 00’s — their student loans will literally follow them to the grave as Social Security checks are already being seized to repay their loans. Even worse, most “owe” several multiples of the original loan amount (including the interest) because the amount due often arbitrarily doubled on multiple occasions by unscrupulous collection agencies in an attempt to bully payment from those without the means to do so.

    But as to the Millennial snowflakes, they only have to pay 10% of their disposable income and can be free of all obligations (with a good credit rating) in as few as 10 years. That’s a really sweet deal, as is only having to pay 3%-5% interest — Gen Xers paid 9% interest….

    Hence I don’t really see what the issue is, and were the student loans of the Millennials to be outright forgiven, it would provoke an incredible visceral backlash from Gen Xers who scrimped and saved to repay theirs — and a related “me too” demand for handouts as they (and the Baby Boomers) enter retirement. That could get ugly….

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