There’s a conundrum in President Biden’s relief plan for student loan debt. The more merciful the government is to debtors, the worse the incentives it creates. People will be more likely to borrow unwisely if they expect the government to forgive their unpayable loans.
This is an old problem for governments, of course, but it’s stark in Biden’s student loan relief plan, especially the income-driven repayment plank, which has gotten less attention than the forgiveness of up to $20,000 in federally held loans.
Here’s how income-driven repayment will work, according to the Department of Education’s Office of Federal Student Aid — assuming it’s rolled out successfully: Borrowers won’t have to pay more than 5 percent of their discretionary income on undergraduate loans (down from 10 percent now). Plus, less of their income will be defined as discretionary. No one earning under 225 percent of the federal poverty level — equivalent to about $15 an hour for a single borrower — will have to pay anything at all on their student loans. The plan would cover borrowers’ unpaid monthly interest so that “no borrower’s loan balance will grow as long as they make their monthly payments,” according to the White House.
That will benefit a lot of borrowers. “We believe it is critical to protect student borrowers who have unaffordable debts,” the department said in a statement for this newsletter.
But there will be unintended consequences. The person who has spelled them out most clearly is Adam Looney, a nonresident senior fellow at the Brookings Institution and the executive director of the Marriner S. Eccles Institute at the University of Utah. I featured his work in this newsletter in April.
“This represents a radical change in student lending,” Looney wrote in an article for Brookings on Sept. 15. On average, he estimates, students might pay back only 50 cents of every $1 they owe. The terms are so attractive that “it will be a financial no-brainer to take out the maximum student loan,” he wrote.
That will increase the cost to taxpayers, he argued. The Penn Wharton Budget Model estimates the changes in income-driven repayment will cost $70 billion over 10 years and could cost an additional $450 billion over that time if the Department of Education automatically enrolls borrowers for whom it has sufficient information. Looney wrote that the $520 billion figure is probably too high but that it “gives a sense of the enormous potential magnitude of the changes.”
Worse is that Biden’s plan will indirectly subsidize the schools and majors that do the worst job of preparing their students for remunerative careers. If you major in mechanical engineering and get a job in the field, you will probably make too much money to qualify for a break under income-driven repayment. If you major in cosmetology, you will probably qualify for a break. Here’s a simplified version of a table that appears in Looney’s article.
“Want a free ride to college?” Looney wrote. “You can have one, but only if you study cosmetology, liberal arts or drama, preferably at a for-profit school.” If you major in something more lucrative, he wrote, “you’ll have to pay full price (especially at the best programs in each field).”
Odds are that no one is going to drop out of Stanford University and get a certificate in somatic bodywork just to take advantage of the income-driven repayment plan. At the margin, though, some people could be more likely to enroll in programs that have poor career potential because their net cost is falling a lot. That would make those schools richer and taxpayers poorer.
I understand that the United States needs all kinds of occupations, not just those that make the most money. Health care industry occupations, for example, might need a subsidy. But income-driven repayment doesn’t differentiate between necessary and less necessary occupations. China isn’t catching up to the United States because it has better-trained cosmetologists.
Biden’s plan eliminates a rule that prohibits institutions from participating in federal grant and loan programs if too many of their students default on their loans. Combined with auto-enrollment of some borrowers, “this eliminates the last remaining policy with any teeth that keeps predatory schools out of the loan program,” Looney said. (In its response, the Department of Education wrote that the elimination of the rule was a statutory requirement, and in any case the rule “captures something on the order of 10 to 15 colleges a year that are really tiny.”)
At many large for-profit schools, Looney wrote, 30 to 75 percent of student loans are returned to students in cash to cover things like living expenses. The Biden plan strengthens the lure of schools that offer lots of cash back, because for many students, the money never has to be repaid.
Biden’s plan is less generous to graduate programs, which soak up a lot of student loans. Since 2006, graduate students have been eligible for Grad PLUS loans, which supplement other types of student loans, enabling many grad students to borrow the entire cost of their studies.
Done right, income-driven repayment can be a form of social insurance. People borrow with the expectation that they will repay in full, but there’s a safety net in case things don’t work out for them. One flaw in Biden’s plan is that many people will not expect to repay their loans in full and will behave accordingly. The other flaw is that too many of the programs that absorb all their loan money aren’t worth it.
On the first point, the Department of Education says that Biden’s plan, with its generous terms, prioritizes helping hard-pressed current borrowers. On the second point, the department says it is working hard to weed out bad programs. It has reopened an enforcement office that the Trump administration effectively dismantled. It’s finalizing a rule to require for-profit colleges to get at least 10 percent of their revenue from sources other than the federal government (including aid to veterans). It plans in the coming year to promulgate a long-sought “gainful employment” rule requiringprograms to show that graduates’ typical loan payments don’t exceed a reasonable share of their income. Betsy DeVos, President Donald Trump’s education secretary, repealed a gainful-employment rule in 2019.
Those are important steps, but Looney said in the interview that income-driven repayment plans will never be the best way of making college more affordable. Many of the beneficiaries are from the middle class and upper middle class, since there are no income qualifications for unsubsidized federal student loans, he argued. Far better would be to increase funding for Pell grants, which go to lower-income students and disproportionately benefit first-generation students who are Black or Hispanic. “If we had a bigger Pell grant, many more people would not have student debt in the first place,” Looney said.
The department responded that it got the “biggest increase in a decade” in Pell grants, wants to double the maximum award and is fighting for free community college. But “those things all require congressional action,” it said. “In the meantime, low-income borrowers are struggling under the weight of their loans and the administration is using the authority it has to provide them with the relief they need.”
That’s fair. But in its effort to do things that don’t require congressional approval, the Biden administration needs to avoid taking actions that have unintended consequences.
Number of the Week
This is the estimated seasonally adjusted annual rate of sales of new one-family homes in the United States in August, according to the median of economists surveyed by FactSet, as of Sept. 26. That is down from 511,000 in July and 1.04 million in August 2020. The Census Bureau is scheduled to release the official number on Tuesday.
Quote of the Day
“The trusts and corporations stood for the larger part of the new power that had been created since 1840, and were obnoxious because of their vigorous and unscrupulous energy. They were revolutionary, troubling all the old conventions and values, as the screws of ocean steamers must trouble a school of herring.”
— Henry Adams, “The Education of Henry Adams” (1906)
Have feedback? Send a note to [email protected].