A smarter, fairer student loan solution
President Biden and members of Congress offered several proposals to reduce Americans’ $ 1.6 trillion in unpaid student debt. As a group, these proposals could reduce outstanding student loans by a third. The proposed relief includes outright cancellation of federal student loans of at least $ 10,000 per borrower, the ability to service student debt in bankruptcy, elimination of tuition debt incurred by students. low- and middle-income workers who attended public institutions, the reduction for low-wage workers in the share of income payable under income-tested student loan programs and the annual forgiveness of loans for those working in the public service. It is also proposed to make community colleges free, make public colleges and universities free for students with low- and middle-income parents, and double the federal Pell Grants, which provide grants to students from poor families.
COVID-19 has produced economic depression for half the country. So doing everything to bring economic help to those in need seems like the right prescription. And we certainly have a large number of young, middle-aged, and even older Americans who are over their heads in student loan obligations. But student debt relief raises three major concerns. The first is generational affordability. The second is fairness. The third concerns incentives to work and to save. These concerns indicate a different direction in student loan policy.
After inflation, Uncle Sam can now borrow at very low rates. As a result, many people, including many economists, think federal deficits are free. They are not. If it did, we could cut taxes to zero, borrow every penny we need, and see interest rates skyrocket. Yes, the Fed would thwart the sale of bonds by printing money to buy them. The result would be hyperinflation. And those who today buy 30-year Treasuries with the current nominal yield of 1.85% would end up holding bonds that are less worth, in purchasing power, than the paper they are on. printed.
In short, there is a limit to deficit financing, and we are getting dangerously close to that limit. Last year’s deficit of 16% of GDP was the largest since World War II. According to the Congressional Budget Office (CBO), debt now represents 100% of GDP, up from 34% ten years ago. The CBO projects a debt to GDP ratio of 200% by 2050. And that only refers to public debt. Most of Uncle Sam’s IOUs have been carefully discounted from the books. These implicit, but no less economically real debts overwhelm those that Congress was supposed to formally disclose. The unfunded liability of social security is one example. According to its administrators, the red ink of the system is $ 53 trillion and growing up. That’s well over two years of GDP.
Add up all of Uncle Sam’s disclosed and undisclosed IOUs, i.e. calculate the country’s fiscal gap – the difference in present value between planned spending and revenue – and we’re talking eight years of GDP. . It is the generational bill that we are throwing in the knees of our children and grandchildren. Accumulating more debt on top of this burden is unacceptable.
Yes, those who have been financially devastated by COVID-19 need an economic rescue. But it has to come from the adults of today who have weathered this storm unscathed or, in fact, prospered financially.
To those who say, “We are far from being on the verge of borrowing. If we were, the rates would be incredibly high, “my answer is,” We are beyond the abyss. The market just doesn’t understand.
And when that happens, things will turn out in no time and there will be high rates and high inflation. Or if the market is right – that inflation won’t lift its ugly head and that long-term Treasuries are real safe investments – taxes will have to be raised to a very high level. We simply cannot borrow eight years of GDP and expect real rates to stay fixed and economic growth to eclipse eight years of production.
Borrowing more therefore represents playing Russian economic roulette with our own financial future and that of our children. In other words, there is no free lunch other than, finally, fight smart and end COVID quickly.
Federal student loan forgiveness is unfair to those who a) just paid off their loans, b) saved or worked their way through college or college, c) privately refinanced and no longer owns federal loans, d) worked for years in a public sector job to get loan forgiveness, or e) actually bought forgiveness by paying off their loans for years based on income.
What is fair is to make student loans dischargeable in bankruptcy. The remaining policies also raise worrying equity concerns. Why, for example, should a female student who borrowed $ X to go to a state university be treated better than her identical twin who borrowed $ X to go to a private university?
Work and save disincentives
Many of the proposals condition their generosity on the income level of the student or the student’s parents. Low- and middle-income parents already face heavy student aid taxes to earn more money and save, which can dramatically reduce college grants and scholarships for their children. And most Americans already face from high to very high to incredibly high marginal labor tax rates. Congress needs to understand how any new student loan generosity will impact work and savings disincentives.
Allow students to borrow at the government’s long-term treasury rate
Much better, fairer, and simpler student loan reform is available. It allows students and their parents to borrow at the rate on long-term government treasury bills. The current rate is 1.85%. College students face a loan rate of 2.75%, graduate and professional students face a rate of 4.30%, and parents, who borrow to help finance their children’s education, do so. facing a rate of 5.30%. Therefore, this proposal, which would allow federal and private loans to be refinanced by the federal government at the prevailing 30-year rate, would significantly reduce the cost of higher education borrowing.
Unlike standard deficit financing used to finance current consumption, this policy involves the government investing in the human capital of our country. It will also provide, through refinancing, immediate relief to students with large debt that they carry at high rates. And that was not going to encumber our offspring with another massive bill to pay “our” largesse.
Laurence Kotlikoff is professor of economics at Boston University.