Reducing Student Debt Burdens Responsibly: Now and in the Future
Many propose cancelling student debt across-the-board to reduce the excessive reliance on student loans. But there are much better ways to reduce student debt burdens responsibly and effectively.
The well-documented explosion in student borrowing over time has led many to propose to cancel large chunks of existing student debt. This is a bad idea.
Many observers from the left, right and center have pointed out why. For example, Kevin Carey recently in The NY Times does a good job of refuting the logic of widespread student debt cancellation. He points out that most student loan cancellation plans are likely to be regressive: borrowers who can most afford their current repayment will benefit the most from loan cancellation. Carey and others also note that proposals to cancel existing debt do nothing to deal with the long-term issue of students in the future borrowing too much. Moreover, cancelling a lot of loans now could make matters worse if future borrowers come to believe their debts will be forgiven as well.
But these legitimate criticisms of loan cancellation plans don’t negate three very valid concerns about student debt levels now and in the future: keeping borrowers’ repayment current during the pandemic; making current debt levels manageable once the pandemic subsides; and sharply reducing the need to borrow in the future. While many have proposed ways for dealing with one or more of these challenges, few if any of the plans so far have laid out a cost-effective way of doing so for all three sets of concerns.
This blog lays out three strategies that meet these daunting challenges that taken together will not cost the federal government any more than what it currently spends on student loan subsidies, defaults and administration.
- First, in the immediate term, millions of student borrowers who are having trouble during the pandemic making their payments need help. The most direct way to do this is to extend the provisions already enacted that allow borrowers to defer their payments until the pandemic crisis has passed.
- Second, in the medium-term, we should try alleviate the adverse effects of having so many borrowers now owing so much student debt. To do this, there should be a triage strategy (like in health care) that identifies why borrowers accumulated debt so that it can be dealt with effectively. This triage strategy should also be applied to future borrowers as well.
- Third, in the longer term, we must explore how to reduce the excessive reliance on loans so this problem of crushing debt does not re-occur. Steps can be taken now to reduce the need for future borrowing and these steps will be sufficient to pay for the costs of the first two strategies.
I. Deferring Payments of Principal and Interest During the Pandemic
The most immediate student loan issue we face is the repayment pressure that millions of borrowers with outstanding debts are feeling during the pandemic. This issue was addressed in 2020 through federal legislation that allowed for principal and interest payments to be paused. This feature has been extended through the end of January 2021 but it seems essential that this provision be extended throughout the duration of the pandemic.
A key question, though, is how much it will cost the federal government to exhibit this form of compassion. The answer is it depends on several factors, including how long the pandemic lasts and what benefit is offered. The least costly approach would be to allow borrowers to continue to defer payments and add unpaid interest to principal. More costly would be if the government foregoes the interest payments on behalf of borrowers who can demonstrate their difficulty in making the payments.
It is worth noting that most outstanding loans were made using federal capital which significantly lowers the cost of covering interest payments compared to loans held by bankers or other private lenders. Paying interest to private holders of student loans involves the government writing checks for the stated interest. In contrast, under direct loans, the subsidy is the government’s cost of money which is significantly lower than what the government would be paying private lenders. As someone who helped lay the intellectual basis for direct loans in the early 1990s, I can say that this response to the pandemic is somewhat of an unintended but positive consequence of the initial legislation.
II. A Triage Approach for Paying Off Outstanding Student Loans
Any strategy to reduce the very real adverse effects of the $1.7 trillion in outstanding debt should include a triage approach. A network of student loan counselors would be established in various locales and on line so that every borrower would be able to consult with a qualified student loan counselor. These counselors would place borrowers into one of the following three categories and produce an individualized plan based on their borrower status.
1.Borrowers who attended institutions and schools of poor quality. The biggest source of student loan defaulters attended schools of poor quality where the federal government failed to exercise due diligence by allowing students at these schools to borrow. While most of these defaulters attended for-profit schools offering short-term training, a number of not-for-profit institutions also provide education and training of dubious value.
Making matters worse, these delinquent borrowers are often hounded for repayment while many of the poorly performing schools continue to operate. To redress this wrong, the debt burdens of those students who borrowed in order to attend these substandard programs should be fully forgiven while the poorly performing schools should be shuttered.
2. Students who attended legitimate programs but whose repayment obligations exceed a manageable share of their income. Perhaps one-third or more of those who currently owe student debt, borrowed too much relative to their ability to repay. Many borrowed to pay tuition that in hindsight was not justified based on their income after they left school. But a significant portion of this debt is attributable to students who borrowed to pay living expenses while they were enrolled. Unfortunately, there is also evidence that some of this borrowing was to help pay living expenses not related to their student status, including providing support to their families.
Whatever the reason for the over-borrowing, however, all those borrowers in this category should be eligible to consolidate and refinance all of their student debt into a single package and repay based on their income after-graduation. The problem with this approach is that income contingency under current rules has become a hodgepodge of repayment schedules that often are costly to the government and borrowers as well as very confusing.
What is critically needed now is the development of a new income-contingent repayment schedule. Borrowers in this category should be able to consolidate and refinance all of their student loans into the new schedule. Moreover, these borrowers should be eligible for loan forgiveness in 20 years so that their loan burdens do not persist well into middle age and beyond.
Also, based on international experience with student loans, ideally this new repayment schedule would be tied to payroll withholding rather than the U.S. traditional reliance on the income tax as the means of calculating income and collecting repayments. Australia, New Zealand, and England have had much better experience with income-based repayments tied to payroll withholding which provides more current and accurate measures of ability to repay than an income-based tax system.
3. Borrowers who can afford their student loan repayment obligations. The third group of borrowers are those who are not having significant trouble with student loan repayment obligations as a share of their income. Although not so frequently discussed, this group of borrowers represent perhaps half of outstanding debt. These borrowers, too, should have the option of refinancing their existing student loans into the new income-based repayment scheme or they could continue with their amortized payments until their loan is repaid.
One policy issue is whether these borrowers should also be eligible for loan forgiveness after twenty years. I believe that would be a good policy choice that would not have significant long-term budgetary consequences.
In moving forward with this triage strategy, there are two key points to recognize. First, as much as a third or more of the $1.7 trillion in debt is the result of unpaid interest being added to principal. While the merits and demerits of adding interest to principal can be debated, most people can probably agree that forgiving unpaid interest is different in kind from forgiving the debt initially incurred.
Second, under existing federal accounting rules, much of the losses that will be incurred on the $1.7 trillion in debt were built into estimates of the long- term federal budgetary costs when the loans were initially made. Thus, the additional costs attached to proposals to cancel debts now are substantially less than the current value of the debt now. Moreover, whatever additional costs are incurred in loan cancellation and forgiveness as described above can be fully offset by cost savings that would result from the efforts to reduce excessive reliance on future borrowing as described below.
III. Reducing Excessive Reliance on Borrowing in the Future
As important as it is to deal with the consequences of currently outstanding debt, the question of how to reduce the longer-term reliance on loans is equally important. To address this longer -term issue of reducing reliance on loans in the future, a number of steps could be taken. These include:
Performance-Based Funding of Remediation. One of the most objectionable aspects of the current higher education financing structure is that many of the students who now take remedial, below-college-level courses must borrow to pay regular college tuition. This is wrong, Students taking remedial courses should not be charged tuition nor should they be allowed to borrow for these courses. Instead, federal, state, and local governments should provide enough funds to pay the providers of remedial courses based on how well they raise the basic skills of students. The cost savings in interest subsidies and default payments would more than pay for this shift to a performance-based system.
Restrict the amount of loans that can be used to pay for living expenses. Much of the outstanding student debt under existing policies are used to pay for the living expenses of students and, in some cases, of the students’ families. In fact, many students in community colleges and some public four-year institutions borrow more for living expenses than for tuition. This pattern runs counter to the theory that loans should enable people to invest in themselves by helping them to pay for the tuition and fees. The U.S. approach is also inconsistent with the many international student loan programs that allow borrowing only for tuition and fees and not for living expenses.
Shifting to a tuition-based student loan model would be greatly facilitated by making federal Pell Grants into a program to help low-income students with their living expenses. Then states and institutions themselves would be responsible for making sure their students could afford tuition through a commitment to institutional aid and a reasonable schedule of borrowing.
Introduce a Risk-Sharing Fee. One reason that student loans and defaults have grown so much over time is that the institutions themselves have no skin in the game; when a borrower defaults, it costs the institution they attended nothing. To reduce future borrowing and help pay the costs of defaults, all institutions participating in the student loan programs should have to pay a modest fee at loan origination that varies inversely with the default experience of that school’s borrowers. Such a fee would not only help to pay for future defaults but would reduce existing incentive for institutions to encourage maximum borrowing by their students.
Require Institutions to Offer Discounts to Their Student Borrowers. Ultimately any successful reform of the student loan system requires reducing the tuition and other charges that students must pay. Otherwise, student loans will simply continue to be the financial underpinning that allows institutions to increase tuition at rates well in excess of inflation.
One way to unwind the tuition spiral in the future is to not allow institutions to let their students borrow the full difference between their sticker price and the resources available to students before they borrow. This requirement to offer discounts to borrowers would help sever the historical connection between ready loan availability and growing tuition charges.
Each of the steps described in this third section would reduce the federal costs of student loans in the future and would help to pay for steps to reduce the adverse effects of outstanding debt as described in the first two sections. They could also help to pay for expansion and reform of other student aid efforts.
If even more savings are needed to produce budget neutrality, the longstanding practice of the federal government paying the interest for borrowers while in school should be re-considered as well. If this were done, student loan subsidies from the front end to the back end of the borrowing process, which is where many of us believe they most rightly belong.
The proposals laid out here are a far better way to address the very real problem of excessive reliance on student loans both now and in the future. Moreover, these reforms can be accomplished within what the federal government already spends on student loans rather than requiring many billions of additional dollars attached to large-scale student loan cancellation.