Public policy and student debt

The United States has a growing problem with student debt. The total of all outstanding student loans is now above $1.5 Trillion. Politicians and others have proposed solutions to managing educational debt, but there is too little discussion of the practicalities. There is no question that we have a major problem and that many young people are starting their adult lives burdened with debt that they may struggle to pay off over decades. Paying down these debts often results in delays to purchasing a home and saving for retirement. As a result, starting one’s working life with debt may have long-term costs that are even higher than most people realize. Someone paying down college debt may not be able to reap the tax benefits of contributing to tax-advantaged retirement plans or employer matching contributions, for example.

Let’s explore some of the proposals for tackling the student debt crisis. Solutions to burgeoning student debt must meet three criteria. They must be (1) economically feasible, (2) equitable, and (3) free from moral hazard. The economic feasibility issue is obvious. The concern with making a solution equitable should also be clear. People who attend college have obtained one of the most valuable assets possible, higher education. People who don’t attend college cannot be expected to shoulder the financial costs, while graduates enjoy all of the benefits. Finally, there is the moral hazard problem. Moral hazard is the situation in which policies give people an incentive to make decisions that are harmful or costly to others.

Easing Bankruptcy Rules for Student Debt

It is extremely difficult to get rid of student debt in personal bankruptcy. While this issue is increasingly well-known, many people remain unaware of this special property. The reasoning behind this aspect of education debt is that the lenders have no recourse to recover their investment. If the bank forecloses on a house because you fail to pay the mortgage, the bank gets the house. Once you have a college degree, you derive a range of benefits. The lender cannot repossess your skills and marketability. In addition, most people finish their educations with little or no net worth, so they have nothing to surrender to creditors.

Imagine that I really want to study creative writing. I choose to attend an expensive private college for my undergraduate degree. By the time I graduate, I decide to pursue a PhD. Over the course of graduate school, I rack up even more debt. I graduate with my doctorate and $100,000 in debt. When I graduate, I want to write a novel. I have no income and no assets. If I can declare bankruptcy, this seems like a logical choice. I have had years of high-quality education to hone my skills and now I can pursue my writing career with all of these benefits and no burden of debt, if I can clear my loans with a bankruptcy filing. This example illustrates educational debt must remain very hard to discharge in bankruptcy. Courts consider an individual’s assets and income to determine the ability to repay debts. I might go on to have a successful writing career in the future, but right now I have no assets and no income and, therefore, no ability to repay. There are a number of proposals for making it somewhat easier to get rid of educational debt in bankruptcy, but even one simple scenario like this example illustrates how hard it would be to structure the rules appropriately.

Canceling Student Debt

I have read a couple of proposals that the government should cancel college debt. On April 22, 2019, Senator Elizabeth Warren, as part of her platform as a presidential candidate, proposed a massive one-time debt college debt forgiveness. Debt forgiveness is simply untenable. First and foremost, simply canceling debt creates a massive moral hazard problem. Students have no incentive to manage costs responsibly when choosing an educational path if they can simply have their debts written off. A related problem is that the schools themselves have no incentive to control costs if students can easily shed their debts.

Senator Warren’s proposal is supposed to be a one-time shot, thereby mitigating the moral hazard issue. She is also proposing to make public colleges and universities free.

There is, however, an even bigger problem with debt forgiveness. Simply canceling debts results in enormous inequity towards people who have already paid down their debts or never had debt at all. Imagine that you have two people who attended the same school, with the same major, and who both graduated with $50,000 in debt (in current dollars). One just graduated and one graduated five years ago. The older graduate has worked hard to make accelerated payments on her debt. She now has only $10,000 in debt remaining. In 2019, we institute large scale debt forgiveness. The recent graduate is able to shed up to $50,000 in debt while the older graduate can only be relieved of $10,000. We are, in effect, creating a system that provides a much larger benefit to recent graduates than older graduates. Or consider another scenario in which one student graduates with less debt because they had work-study jobs or other part-time work. It is certainly not fair to give greater advantage to a student who racked up more debt because they didn’t take work-study hours in college.

The idea of debt forgiveness also faces problems of inequity. Ultimately, taxpayers bear the costs of debt forgiveness. People who did not attend college or who attended less-expensive institutions end up subsidizing those with the most expensive private educations. Consider the irony that an academic study proposing debt forgiveness was written by researchers at Bard College, a private college that costs $76,000 a year to attend. There is no plausible justification that people who don’t attend college or who make less expensive choices should cover the debts for people who attend a college like Bard.

Conclusions

Solutions to the student debt crisis that make it easier for graduates to shift the burdens of their choices to others have substantial problems. The largest concern is that somebody will have to pay debts while the students retain all of the benefits of their educations. Debt forgiveness amounts to a highly regressive tax because college graduates tend to be much better off than non-graduates. Debt forgiveness will also tend to exacerbate out-of-control escalation in educational costs. Expanded access to debt has fueled the rapid increases in college costs. Debt forgiveness would make it even easier for colleges to increase costs because students would become even less cost sensitive.

On its face, Warren’s proposal seems to avoid the regressive tax issue because she plans to cover the costs of debt forgiveness by a tax on the very wealthy. This is not a logically sound argument. If it is decided to tax the very wealthy, the resulting funds should be applied in an equitable manner for the benefit of all. This would not be the case with Warren’s proposal. It is estimated that fully 28% of college graduates with a doctoral or professional degree would qualify $50,000 in debt forgiveness. The amount of forgiveness is tied to income, but this is easy to game. Would this be based on a doctor’s salary as a resident? Resident physicians typically earn around $60,000 a year, although many will make hundreds of thousands more per year as soon as soon as they leave residency.

The practical solutions to the growing burden of college debt, one which does not create problems of moral hazard or inequity, is to control the costs of education. If college costs were to grow no faster than inflation, next year’s graduates will at least be on a level playing field with last year’s graduates in terms of costs and benefits. Going forward, we have to reverse the trend of educational cost growth.

For those who have left school with debt, the situation is difficult. As adults who enjoy the benefits of higher education, they cannot expect that everyone else will retroactively assume the costs that they incurred. Like it or not, people with educational debt assumed their loans of their own free will and must repay these debts. There is simply no fair solution for large-scale debt forgiveness or substantial liberalization of bankruptcy rules for educational debt.