Forgiveness of outstanding student loans has been a recurring theme in political debates over the estimated $ 1.6 trillion in debt that the US government and private lenders hold. Calls for such forgiveness have increases now that the Joe Biden administration is preparing to take office.
However, partial or full cancellation of student loans is “regressive,” according to a recent discussion paper, titled “The distributive effects of forgiveness for student loansBy Professor of Finance Wharton Sylvain Catherine and Constantine Yannelis, professor of finance at the Booth School of Business at the University of Chicago. The conclusions of the article are actively discussed on Twitter.
“Any policy that is a universal loan forgiveness policy or a capped forgiveness policy – say debt forgiveness up to $ 50,000 – is going to give higher income earners most of the dollars in forgiveness,” Yannelis said, who was interviewed with Catherine on Wharton Business Daily Radio Show on SiriusXM. (Listen to the podcast above.) “This problem is compounded if you look at the present value of the loan and explain the fact that the people at the bottom of the distribution won’t pay off a large chunk of their loans anyway, or go to them. pay later than the richest.
The paper explored the distributive effects of student loan forgiveness policies. It also presents a framework for calculating the present value of student loans and uses it to present new findings on the escalation of loan forgiveness options.
Essentially, research shows that forgiveness would benefit richer borrowers more than low- and middle-income borrowers. The authors said the remission results would be uneven because “higher incomes took larger loans, but also because, for lower incomes, balances greatly overstate present values.”
“Basically most of the benefits will end up going to the higher income earners.” –Constantine Yannelis
Under a universal loan forgiveness policy, in terms of present value, the average individual in the top earning decile would receive $ 6,021 in forgiveness, compared to $ 1,085 for those in the bottom decile, the newspaper said. . In fact, households in the richest 30% of the income distribution receive almost half of all dollars donated. Trends are similar for debt cancellation policies up to $ 10,000 or $ 50,000, with higher-income households seeing significantly more loan forgiveness, the researchers write.
The benefits of canceling student loans are also unevenly distributed by race and ethnicity, Catherine and Yannelis found. The average loan balance is highest among blacks at $ 10,630, while that of whites is $ 6,157 and that of Hispanics and others is $ 3,996. Adjusted for the present value of these loans, universal loan cancellation would result in roughly equal average benefits for whites and blacks, but would produce significantly lower average benefits for Hispanics and other groups. the researchers noted.
Loan balances are misleading
According to Catherine, student loan balances are not the right metric to consider. “Instead, we calculate current values based on what people are actually paying back, which depends a lot on their income,” he said.
People with education debt can enroll in the government’s Income-Based Repayment (IDR) program, in which they pay no more than 15% of their “discretionary income,” which is the portion of their income above $ 150. % of the poverty line. After 20 or 25 years, their loan is canceled. “As a result, under current law, their loan may be worth much less than the balances suggest,” Catherine said.
“Overall, we find balance forgiveness to be a strongly regressive policy; the top decile would receive as much as the bottom three deciles combined, ”said Catherine. “Instead, we are proposing to enroll more people in the IDR, an option that people are not using enough.” A “more phased” policy – where the benefits of canceling loans flow more to the middle class – would be to expand Income-Based Repayment Plans (IDRs) that tie payments to income, the authors said.
A path to more equitable earnings
The researchers looked at the likely outcomes of three scenarios where all borrowers are enrolled in IDR plans. In the first case, borrowers start paying on income above 150% of the federal poverty line and pay 10% of that income. In the second scenario, the remaining balances are canceled after 10 years. In the third, the reimbursement threshold is raised to 300% of the federal poverty line, against 150% in current plans.
The study finds that placing all borrowers in IDR leads to a significant discount for middle-income borrowers, unlike universal or capped discount policies that disproportionately benefit high-income borrowers. People in the third to seventh deciles receive 61% of the total forgiveness, and those in the bottom half of the income distribution receive more than half of the earnings. In terms of racial and ethnic effects, “forgiveness amounts are twice as high for blacks as for whites and the general population,” the researchers found. Hispanics and others see lower loan forgiveness amounts compared to other groups.
“Increasing the generosity of income-based repayment plans, or enrolling more people in those plans, leads to the benefits of forgiveness towards the lower and middle class, rather than towards the upper percentiles of the income distribution,” said Yannelis.
“It’s not just a question of emotion. We have to look at the numbers to do some kind of policy assessment. ” –Sylvain Catherine
Raising the income threshold above which borrowers repay loans from 150 percent of the poverty line to 300 percent dramatically increases the gains for low-income borrowers. “Having an income-based repayment program that only captures wages above three times the poverty line means that someone who earns $ 40,000 a year and is single will pay nothing – or very little – and then his balance will be forgiven. after 20 years, ”said Catherine. However, making this IDR policy more liberal makes little difference to someone earning $ 100,000 or $ 150,000, he added.
In most cases, people who have spent more time in school work in professions like medicine or law, earn well and are able to pay off student debt, Yannelis said. But this is not true for everyone who has a higher education, he added. “Some people struggle for some reason. And that’s one of the strengths of these income driven repayment plans. If someone has a high debt balance, they went to law school or medical school, and for some reason things didn’t work out, they don’t have to make those really high payments. So there is built-in insurance for borrowers. “
The main takeaway from their research is that policymakers need to be “very careful” in developing student loan management policies, “because they may appear progressive on paper, but they are very regressive,” said Catherine. . “We have to do qualitative exercises. It’s not just a question of emotion. We have to look at the numbers to do some kind of policy assessment. “
A difficult problem to manage
According to an internal analysis by the US Department of Education, the government faces losses of $ 435 billion on the $ 1.35 trillion in student loans it holds, The Wall Street Journal reported in November. The analysis did not include about $ 150 billion in loans from private lenders and government-backed, he noted.
However, the student loan market apparently lacks the rigor seen with conventional bank loans. The government lends more than $ 100 billion annually to students to cover the tuition fees of more than 6,000 colleges and universities, the Newspaper declared report. “It does not take into account factors such as credit scores and field of study, and it does not analyze whether students will earn enough after graduation to cover their debt,” he said. added.
The new administration has proposed a series of changes that could affect more than 42 million student loan borrowers, The New York Times reported last month. Significant student debt forgiveness also exists under current programs for public sector employees, teachers and borrowers under income-based repayment plans for more than 20 years, note Catherine and Yannelis in their report. article.
Meanwhile, the US Department of Education last week expanded the forbearance period for student loans until January 31, 2021, in response to the pandemic. This extension also applies to loan repayments and the freezing of accrued interest and collection activities, including the garnishment of wages against defaulters, according to one. CNBC Report. Student loan borrowers could get additional relief that could extend through April 2021 thanks to bipartisan $ 908 billion coronavirus stimulus bill, like Forbes reported.