A recent Bloomberg editorial stated that the key to fixing our student loan system is to simplify student loan repayment. One idea is to reduce the number of repayment plans down from nine to two, which is what Senator Lamar Alexander (R-TN) proposed in the HEALS Act.
If it’s that simple, why hasn’t the government taken action yet?
On its face, simplifying student loan repayment seems like a no-brainer. Why not make it easier for students to sign up for income-driven repayment plans? Doing so could reduce default rates and get more borrowers paying back their loans.
But in actuality, simplifying student loan repayment without addressing the deep-seated problems in America’s student loan system could actually make the student debt crisis much worse.
The Downside of Simplifying Student Loan Repayment
Policymakers obsess over the wrong statistic: student loan default
From a financial perspective, when a borrower defaults on federal student loans, you’re usually guaranteed to get paid back more money than if they stay on income-driven repayment.
That’s because the government can intercept tax refunds, garnish wages at 15% of pay and even seize Social Security income.
If a borrower signs up for PAYE or REPAYE, the two most popular income-driven repayment plans, they would pay 10% of their income, which is less.
Additionally, for borrowers who default, the government adds compounding interest and fees.
The typical borrower in default might owe around $10,000. That’s a small enough balance that the government will eventually get its money back with its extremely strong collection powers.
A professional who never defaults but borrows $200,000 might pay back a fraction of that sum on an income-driven repayment plan. The federal government, therefore, profits more from an individual borrower long term when they default compared to if they signed up for an income-driven plan.
I’m not hoping the government makes more profit on student loans — far from it. I’m simply saying that, in my years in the student loan industry, I’ve seen policymakers make minimizing student loan default the ultimate goal.
The real ultimate goal should be to encourage affordable degree programs and to halt runaway tuition expenses.
Yes default matters as a statistic, but it’s not the only thing that matters.
Repayment of student loan principal is a better metric for success
According to the Congressional Budget Office, the government can expect to subsidize 43.1% of loans that enter an income-driven repayment plan under fair value accounting measures.
Having the insurance of an income-driven repayment plan to protect borrowers is extremely important. However, if a borrower is unable to make progress paying down their loans, that’s an indictment of the school that provided a costly education that their graduates have difficulty paying off.
If we want to subsidize low-income borrowers or professionals who go into public service jobs, we should accomplish that with direct aid and scholarships instead of allowing unlimited borrowing because it would be much cheaper and create less anxiety among students.
Default is an indictment of a student’s higher education program; however, the primary statistic that should matter for student loans — and what schools should be measured on — should be how many borrowers are able to pay back the cost of their degree.
Will a new repayment plan create a marriage penalty?
Currently, you can file taxes separately from your spouse and exclude his or her income from student loan repayment. However, the plan proposed by Senate Republicans would probably force borrowers to include their spouse’s income in their monthly repayment calculation.
I already encounter borrowers thinking of avoiding marriage because of the higher cost of student loan repayment; however, I can usually show them how they don’t need to worry thanks to the existence of the PAYE repayment plan.
If simplified student loan repayment forced people to include spousal income, borrowers would have a strong incentive to not get legally married.
Eliminating the tax bomb would incentivize more borrowers to sign up for income-driven repayment
Eliminating taxes on student loan forgiveness is something I believe will eventually happen. It should happen, because asking a borrower to pay hundreds of thousands of dollars in taxes decades after a decision they made at 22 years old is quite harsh.
That said, the tax bomb is one of the few things that gives borrowers hesitation about borrowing the maximum and paying the absolute minimum on their loans.
Consider a chiropractor with $200,000 in student loans. Let’s assume he earns $50,000 and maxes out his IRA contribution.
Compare the cost of the REPAYE plan below with taxes owed and with no taxes owed:
Without owing any taxes on student loan forgiveness, the cost would fall by more than half for this borrower. Notice that the cost of his repayment would’ve been the same if he owed $100,000 or $1 million.
If the tax bomb is eliminated, borrowers might also realize that they don’t need to worry about the amount of loans they borrow, so they could throw caution to the wind and not worry about getting an affordable degree once their debt exceeds a certain point. They could try to find the highest quality degree regardless of its cost.
That leads to the primary reason simplifying student loan repayment is pointless without one major change: improving access to education.
The best way to fix the student loan system is to address unlimited borrowing while preserving access to education
Simplifying student loans in America has not been accomplished because it’s extremely difficult.
Of the nine repayment programs assailed as unnecessary by senators, only three are actually relevant: the Standard 10-Year, REPAYE and PAYE.
REPAYE is the newest of those three plans passed during President Obama’s tenure. It seeks to increase the length of time graduate students must pay from 20 years to 25 years to get forgiveness. It also eliminated the ability to exclude a spouse’s income from student loan repayment.
An earlier plan proposed by Senate Republicans would allow high-income earners to pay even less than with REPAYE. Senator Alexander at one point proposed allowing 20-year PAYE for everyone without counting spousal income.
None of these proposals account for the elephant in the room: higher education costs are too high. It shouldn’t cost $400,000 to go to medical school. It shouldn’t cost $700,000 to go to dental school. It shouldn’t cost $250,000 to go to law school.
Other countries regulate what their colleges can charge
Education costs are high because Congress allows borrowers to take out an unlimited amount of loans to finance degrees, which has led to runaway costs set by schools that have no incentive to reduce the amount they charge.
In Australia and the U.K., which both have income-driven repayment programs, students have a limit on their borrowing, which forces the schools to adapt and charge less. Universities and colleges are also more strictly regulated.
Some lower-income students and students of color could face challenges gaining access to educational programs with borrowing caps. That problem could be solved by direct aid to underrepresented groups in the form of grants or government guarantees to address racial inequality in education. We know that Black families have to borrow far more than white families because of systemic inequities in household wealth.
These issues should be addressed, and unlimited borrowing isn’t the solution.
Bankruptcy should also be an option for student loan borrowers. To keep interest rates on student loans low, perhaps the government could help lenders share some of the losses like the Affordable Care Act does with health insurance companies. Then the government could cut off both nonprofit and for-profit programs from federal aid if their students have high default rates.
Or perhaps college should just be free. At least then the system would likely be more honest in the incentives it creates.
If student loans are a tax, why not borrow the max?
Any student loan reform proposal that does not address the primary problem of the student loan system is simply a Band-Aid, not a permanent fix. The primary problem with student loans is that schools have zero regulation on what they can charge for education.
Imagine a simplified student loan repayment system with auto-enrollment in income-based repayment plans where borrowers have no tax bomb on forgiven debt. Student loan repayment would be a tax on income for a stated length of time.
Students should borrow as much as possible once they have a large enough balance that would not likely be paid back. Because if you’re going to pay 5%, 10% or 15% of your income for student loans, you ultimately don’t care what the balance is because that’s not connected to your total debt.
So, if Congress and the current or future White House administration seek to address student loan reform, they need to address the outrageous cost of getting a degree in America. Otherwise, student debt will continue to grow at an alarming rate until it starts to crowd out other policy priorities like healthcare, housing, infrastructure and other public goods.
Current attempts to simplify student loan repayment are a temporary pain reliever masquerading in policymakers’ proposals as a cure.