Introduction: The proportion of students leaving school with debt, the average debt load of students, and the number of older workers entering retirement with unpaid student debt has steadily increased over the last few decades. The financial stress from higher student debt burdens has adversely impacted many people by delaying marriage, household formation, home purchases, and the process of saving for retirement.
In response to this crisis the Biden Administration has advocated for and implemented several policies. These policies include –
· A one-time debt discharge of up to $20,000 for federal student debt.
· New more lenient Income Driven Replacement (IDR) loan plans,
· Increased financial assistance for students attending community college
· Increased Pell grants
The Biden-era proposals are unlikely to substantially alter the trajectory towards higher student debt levels and associated financial problems and hardships.
The proposed one-time discharge of student debt may be ruled unconstitutional by the Supreme Court. The proposed one-time discharge of student debt will not assist students who are now entering college.
IDR programs have proven to be ineffective at reducing student debt burdens for a variety of reasons.
Many of the first set of borrowers eligible for IDR relief did not have their loans discharged in a timely manner. Problems causing the delay in discharge have not been fully addressed.
The current system requires student borrowers to choose between an IDR loan and a conventional loan as soon as repayment begins when they have little information about their future marital status and household income.
Some students who enroll in IDR programs end up paying more on their student loans because of changes in income over their lifetime. Student borrowers who choose the conventional loan over the IDR loan are ineligible for debt relief, even if they experience great hardships in the future. The Biden IDR reforms do not fix problems associated with having to choose between an IDR loan and a conventional loan with little information about lifetime income or finances.
Proposed increases in financial assistance to students attending community college and increases in Pell grants are helpful. However, the increased relative cost of four-year college to two-year college could reduce the number of qualified low-income and middle-income students attending four-year schools. Moreover, many students who transfer from community college to four-year college often lose a substantial amount of the college credit when transferring.
The alternative proposals described in this memo result in fewer economic distortions than the Biden Student debt proposals. Two types of proposals are considered here.
The first type, debt relief reforms, attempts to target debt relief to the people most likely to experience payment problems. The reforms proposed here involve modification of the standard federal student loan contract and modifications to the bankruptcy code.
The second type attempts to reduce total debt incurred in college. The reforms proposed here involve substantial reductions in debt incurred during the first-year of college and policies designed to improve on-time graduation rates.
Reforming Student Debt Relief Programs:
Three student debt reform proposals are considered here.
The first involves the modifications of the basic federal student debt contract to allow for automatic elimination of interest rates charges 10 or 15 years after the initiation of loan payments. The new student loan contract obviates the need for IDR loans. The elimination of interest is tied to increased use of the IRS to collect student debt once interest is eliminated.
The second and third proposals involve modifications of the treatment of student debt under the bankruptcy code. The second proposal treats private student loans as consumer loans, which are dischargeable in bankruptcy. The third proposal provides federal student loans priority over consumer loans in chapter 13 bankruptcy.
The three proposals presented here more accurately target relief to the student borrowers who are most in need of assistance. The proposals will be effective at reducing the number of older workers entering retirement with outstanding student debt. The proposals are fair to both student borrowers and taxpayers.
Proposal One: Phase out IDR loans. Modify the standard federal loan contract to automatically convert the student loan to a zero-interest loan 10 or 15 years after the onset of loan repayment. The remaining balance on the zero-interest loan becomes a tax obligation payable in equal installments over a 10-year period.
Analysis: The proportion of older workers entering retirement with debt, including student loans, has increased steadily over the past few decades. Many retirees with student debt now have their Social Security checks garnished. The modified student loan program would reduce the number of people entering retirement with unpaid student loans.
IDR programs have not been successful in reducing the number of older workers retiring with student debt.
The modified student loan contract described here is better both for taxpayers and for student borrowers than the IDR program in several respect.
The IDR program creates an incentive for some students to increase the amount they borrow. By contrast, under the modified student loan contract described here people who borrow more will always repay more than people who borrow less.
The modified student loan contract will automatically assist student borrowers with lower than anticipated lifetime earnings. The program does not require students to correctly anticipate their lifetime earning to enroll in the optimal loan.
The interest elimination under the modified student loan contract is not contingent on accurate reporting of loan payments by loan servicers.
The use of the IRS as a collection agent after the elimination of interest is necessary to facilitate payment on a 0 % interest loan. The use of the Treasury to collect student debt is preferable to letting the debt fester leading to garnishment of Social Security.
Proposal Two: Modify the bankruptcy code to allow for discharge of private student loans during bankruptcy.
Analysis: Private student loans with high fees, rates and annual caps tend to have more in common with consumer debt than with federal student loans. The rational for restricting discharge of federal student loans, the protection of taxpayers, does not exist for private student loans. Consequently, private student debt should be treated like a private consumer loan in bankruptcy.
A provision allowing for the discharge of private student debt and parent plus loans in bankruptcy would increase the incentive for lenders to scrutinize the ability of the borrowers to repay loans. The proposal would also increase interest rates charged on private loans.
Proposal Three: Provide priority to federally guaranteed student debt over other consumer loans in Chapter13 bankruptcy while maintaining current rules in chapter 13 on private student loans and current Chapter 7 rules.
Analysis: The chapter 13 bankruptcy attempts to provide debtors with a fresh start by relieving them of debt after completion of a payment plan. However, student debt is not discharged after completion of the chapter 13 payment plan.
The 2005 bankruptcy bill moved many debtors from chapter 7 bankruptcy to chapter 13 bankruptcy. Today many people with student debt in Chapter 13 leave bankruptcy with substantial outstanding student debt.
A modification to current chapter 13 bankruptcy rules which provides priority to federal student debt over consumer loans during the bankruptcy period would facilitate greater reduction of student debt during bankruptcy. This change would benefit taxpayers because repayment rates by older student loan borrowers are likely low and student debt is forgiven upon the death of the borrower. This change would provide relief to the people who are having the hardest time repaying their student debt.
The proposal presented here retains the 2005 rules that made it more difficult to qualify for Chapter 7 bankruptcy and obtain an immediate discharge.
Reducing Debt Incurred in College:
Two reforms designed to reduce college debt are considered here.
The first proposal involves the reduction or even the elimination of the use of federal student debt during the first year of college.
The focus on debt incurred during the first year of college is less ambitious than previous proposals that called for free college or debt-free college.
The most ambitious variant of a debt-free first-year proposal would eliminate all debt for all first-year students. The approach would prohibit student debt until a student completed one-year of course work. A less ambitious variant would increase grant-based financial assistance for first-year students and reduce access to federally guaranteed student loans.
The second proposal involves the adoption of policies and programs to improve on-time graduation rates.
Both proposals reduce total debt incurred. Both proposals provide the greatest assistance to the student borrower having the most difficulty repaying their loans.
Proposal Four: Reduce or eliminate debt for first-year students. Steps taken include increased grants for first-year students and students taking college-level work prior to full-time enrollment, increased access to college work prior to full-time enrollment, and the publication of first-year debt incurred at universities.
Analysis of Proposal Four:
Many students take on $5,500 in student loans in their first year of college. The elimination of first-year debt reduces typical debt for a student that borrowers every year. The impact of first-year debt reduction would be largest for people who leave school early who are around 3 times more likely to default on their loan than student borrowers who get a degree.
The elimination of first-year debt will decrease the amount of student loan interest paid by both taxpayers and student borrowers. The government pays interest on subsidized student loans until the student leaves school while the student-borrower with an unsubsidized loan is charged interest even when attending school.
Some post-secondary education is increasing necessary for career advancement. Targeting financial aid for first-year students is the most effective way to enroll students who might otherwise be deterred from even trying college and could allow some people to return to college after receiving some job experience.
A debt-free first year might make three years at a top private university affordable for more students and facilitate transfers to private universities after the completion of a free-year at a public university. However, private schools would remain more expensive the public schools.
The proposal should aid first-year students at both two-year and four-year institutions. The Biden Administration has focused on free-community college. This proposal would allow more qualified applicants to immediately apply to a four-year option.
The existence of increased assistance for courses prior to students starting full-time undergraduate work could be linked to a regulation prohibiting federal student loans until student completed nine credits of course work. This regulation would reduce debt by students who are unprepared for college and unable to repay the loans.
In theory, the program could be designed to make the first year of college debt free for all students. The extent of the reduction in first-year debt will depend on the size of additional subsidies, which come from federal, state, and private sources.
Proposal Five: Implement Policies to Improve On-Time Graduation Rate including policies that better prepare students for college level work, programs that assist students who are struggling to graduate on time, the publication of university-level and department-level on-time graduation rates and other incentives for universities to improve on-time graduation rates.
Analysis of Proposal Five:
Only around 41 percent of undergraduates graduate in four years. An increase in the percent of students graduating on time would substantially reduce student debt burdens.
Around 73 percent of students taking five or more years to graduate incurred debt compared to 62 percent for students who graduated in four or fewer years. Average federal student debt for students with debt was $31,639 for students taking five or more years to graduate compared to $25,528 for students taking four or fewer years. In addition, quicker graduation reduces the amount of private student debt incurred.
The process of improving on-time graduation rates starts with programs designed to improve k-12 education outcomes. Many students start their post-secondary careers with remedial courses that do not count towards graduation. Some of the remedial courses are taken in community colleges. People who transfer from community college to four-year school tend to lose a substantial number of credits when transferring.
Colleges can and should implement programs to identify students who are not likely to graduate on time and to provide incentives and assistance to these students. Some students are failing to graduate on time because key courses for completion of a major are not always available. On-time graduation could be facilitated by increased use of summer or on-line courses for students who fall behind schedule. This effort may require additional financial assistance for summer work.
Colleges should be graded and ranked on the extent to which their students graduate on time. The grade for on-time graduation rate would be linked to the competitiveness of the college because highly competitive colleges tend to have higher on-time graduation rates.
Concluding Thought: The progressives (Senator Sanders and Senator Warren) and the Republicans have a clear approach to student debt. The progressives want all current debt forgiven and would like future students to have a debt-free college experience. The Republicans prioritize taxpayers over student borrower. They support limited IDR programs but basically oppose debt discharges and debt-free college proposals.
Candidate Biden during the 2020 campaign did not support debt discharges. The recent student debt-discharge proposal appears to be an effort to motivate progressive voters. The authority for this program depends in part on law allowing debt relief during emergencies. However, most COVID-era emergency programs have ended. Congress has not explicitly approved expenditures for this debt discharge. Treasury is already taking steps to respond to the debt limit. Given these fiscal circumstances and the pending litigation, the proposed one-time discharge of student debt is not likely to happen.
The proposals offered here differ substantially from other proposals under consideration. The proposals presented here including the eventual elimination of interest on the standard student debt contract and the reduction in debt incurred by future first-year students will halt the trajectory towards higher student debt burdens in a way that is fair to taxpayers.
The author, David Bernstein, is an economist living in Denver Colorado. He is the author of A 2024 Health Care Reform Proposal available here, https://app.sellwire.net/p/2Uv