Category: Student debt

This post addresses some general issues on IDR loan payments and some specific issues raised by the Biden Administrations reform efforts.

What determines the choice between an IDR student loan and a traditional student loan?

An IDR loan is the most viable way to prevent default tor many people leaving college with substantial student debt and a relatively modest starting salary. However, many people who initially enroll in an IDR program because it is the only viable option will end up paying substantially more over the lifetime of the loan than under a standard student loan contract.

• A student borrower leaving college with $25,000 in student debt at a 5.0 percent interest rate would pay $3,182 per year on their student loan.  Total loan payments on an IDR loan that charges 10 percent of disposable income would come to $1,813.

The payment differential between the conventional and IDR loan will change with changes in income and marital status.

Increases in salary increase IDR loan payments which can cause the borrower to shift to a conventional loan.  The decision to convert the IDR loan to a conventional loan ends the possibility of a partial loan discharge.  (It would usually be very foolish for a person to turn down a nice raise at work to remain eligible for a loan discharge).

Increases in household income after marriage will often increase IDR payments and can induce the borrower to shift from IDR loans to conventional loans.  A married IDR borrower can reduce the increase in the student debt payment by filing a separate return but a decision to file separate returns will often result in a substantial increase in tax obligations which, as discussed below, offsets any savings on student loan payments.

When should married couple with an IDR loan file a separate return instead of a joint return?

A married couple where one or both spouses have an IDR loan could reduce their combined student loan payments by choosing filing status married filing separately, but it is highly likely this choice will substantially increase their tax obligations. 

Articles on whether a married couple should file a joint return, or a separate return generally focus steps a taxpayer must take to insulate themselves from their spouses tax liability and the loss of tax deductions and credits.

A larger impact of the decision to choose the file married separately returns stems from a shift in tax deductions towards the spouse with lower income.

• A married couple making $120,000 filing a joint return taking the standard deduction of $27,700 will pay federal tax of $10,921.    The additional loss of the tax deduction for student loan interest would reduce the couple’s tax obligation to around to $10,371.

• The same married couple where one spouse makes $40,000 and the other spouse makes $80,000 where each spouse takes the standard deduction of $13,950 will pay a combined household tax of $12,787.

The decision to file separate returns instead of joint returns will for this couple result in an increased tax obligation of $2.408.  The increase in tax obligations may exceed the reduction in student loan payments from the IDR option.

Many newly married student borrowers will immediately switch from an IDR loan to a conventional because of this tradeoff.

What is the potential income of divorce on successfully paying off a student loan under IDR programs.

IDR relief may not be available for a person who switches from an IDR plan to a conventional plan upon marriage and then gets divorced and wants to reenter an IDR program.  A current Biden Administration effortto update and modify IDR loan records, described below, includes a provision that allows for payment credits on IDR loans for payments made under multiple plans.  But this one-time fix may not be available in the future.

Changes in student loan payment obligations caused by changes in income or marital status make IDR loans a risky way to provide student loan debt relief.  The more effective option outlined here involves selective elimination of interest charges at the beginning of a career and upon the maturity of the loan.

Why are so few people getting IDR loans discharged?

Even after accounting for conversions from IDR to conventional loan programs due to changes in income and marital status relatively few student borrowers are obtaining timely debt discharges from IDR loans.  A GAO report found that as of June 1, 2021, only 157 IDR loans had been approved for forgiveness even though another 7,700 loans were potentially eligible for forgiveness.

Both borrower and loan servicer errors result in inaccurate reporting of student loan payments and annual recertifications as documented in this  CFPB report.  One reason why it is difficult to track payment errors is that in some years or months the required payment on the IDR loan is zero, an amount that is indistinguishable from the amount received if the person failed to make a payment on time. 

A failure to annually recertify income and household size can result in loss of IDR payment status.  This document  indicates that applicants under the SAVE program who fail to recertify will be ineligible for a loan discharge while applicants on the PAYE, IBR or ICR plan can remain in the IDR plans, but their payment will be based on the 10-year standard repayment plan.

What can be done to increase on-time IDR discharges?  What are the limits of efforts to improve the administration of IDR loan programs?

There have been several attempts to facilitate IDR discharges by reviewing, modifying, and updating student loan payment records.  Congress passed legislation in 2019 to help facilitate IDR loan discharges.   The Biden Administration announced an IDR review effort in April 2022. The current Biden Administration effort to update and modify IDR loan records adjusts payment counts for forbearances, deferments and payments made under other payment plans.

The Biden Administration has been fairly aggressive about helping IDR loan applicants obtain a loan discharge. Future Administrations may not place a high priority on facilitating student loan discharges, hence IDR loans unlike other loans are impacted by a form of political risk.

Despite these ad-hoc payment count adjustment efforts the number of IDR discharges remains low, and many discharges occur later than stipulated under the contract.  Again, the better solutions outlined here involves selective elimination of interest charges at the beginning of a career and upon the maturity of the loan.

What are the major changes to the IDR program under the Biden Administration’s SAVE program?  

The major changes announced under the SAVE program listed here include:

• Increase protected income for loan payments from 150 percent of the federal poverty line (FPL) to 225 percent FPL.
• No interest charge when the IDR payment is lower than interest due.
• Allows married borrowers to exclude spouse’s income when filing separately.
• Disallows existence of spouse in household size calculation when filing married separately.
• Starting in 2024, cuts payment rate on SAVE loans to 10 percent to 5 percent of disposable income.
• Links number of years needed to obtain a loan discharge to initial size of the loan balance. Students with loan balances below $12,000 are eligible for a loan discharge at 10 years.  Each additional amount borrowed of $1,000 results in one additional year for eligibility of a discharge up to 20 or 25 years.

Does the SAVE program prevent loan balances from increasing overtime?

The SAVE feature prohibiting interest charges when the SAVE payment is less than the interest charge will prevent an increase in the student loan payment when the borrower makes payments on time.  However, student loan balances could increase if the borrower fails to make payments or if the borrower pauses student loan payments to go back to school.  

Does the SAVE program create an incentive for people with less than $12,000 in debt from going back to school and pursing more education.

The SAVE rules appear to create a disincentive for more education by recipients of a two-year degree with less than $12,000 in student debt.  

The person with up to $12,000 in debt who chooses to stop further education will have the remaining balance on the initial $12,000 in debt forgiven after 10 years, as long as the person makes the payment on the SAVE loan.

The person who goes back to school and formally pauses student debt payments will likely have around $30,000 in total debt upon completion of a bachelor’s degree and no chance for a loan discharge for another 20 years.

It may be possible for a student to maintain payments on the original IDR loan while in school and get a partial discharge of debt after 10 years.  The rules appear ambiguous on this point.  This is a question for the Department of Education.

How does the SAVE option impact student debt payments for a typical Bachelor’s degree recipient? 

The typical bachelor’s degree recipient will end school with around $30,000 in student loans and start her career at a relatively low salary.   The initial payment on the loan, currently 10 percent of adjusted gross income over 225 percent of the federal poverty line, is relatively small and is unlikely to initially cover the interest on the loan.  

The SAVE loan borrower essentially has a zero-interest loan with an unchanged $30,000 balance until the borrower’s salary rises to the point that her payment (defined as 10 percent of the difference between AGI and 225 percent of the FPL) falls below interest charges.

A person who maintains a low-salary and low household income will make modest student loan payments for twenty years and have the loan forgiven assuming the loan payments were correctly reported by the loan servicer.

A student borrower who obtains a higher salary or household income would have to make higher loan payments.  The SAVE loan does not limit the monthly payment on the loan when AGI rises.   Other programs like PAYE and IBR cap the monthly payment at the payment for a 10-year standard loan, but these programs would allow the loan balance to increase if the loan payment did not cover interest costs.  

Dave Ramsey has noted that many IDR borrowers could pay more on their student loan than the borrower with a standard 10-year loan both because payments could persist for 20 to 25 years and could rise substantially with income.

Is debt forgiven under IDR programs taxable?

The American Rescue Plan exempted dischargeable student debt from federal tax for debt discharged prior to December 2025.  However, some states treat dischargeable student loans as taxable income.

Authors Note:  A newly published SSRN paper examines the impact of both additional education and additional student debt on the ability of households to make a $400 emergency payment.

The Biden Administration responded to the Supreme court ruling disallowing student loan forgiveness by announcing a new Income Driven Repayment Plan (called the SAVE plan) and by facilitating discharges of existing IDR loan applications, through a modification of the count of previous payments.  

This memo summarizes and evaluates these Biden Administration student debt initiatives and discusses alternative relief measures.

Biden Administration Student Debt Initiatives:

The SAVE PLAN described here replaces the REPAYE plan.  Some features of the SAVE plan are implemented in the summer of 2003.  Other features are scheduled to be implemented in July 2024.

These three features of the SAVE plan will be implemented this summer.

• Increase in the amount protected from payment obligation from income less than 150 percent FPL to income less than 225 percent FPL.
• Elimination of interest charges when monthly payment does not cover monthly interest charge.
• The elimination of spouse’s earnings in calculation of SAVE payment.
• The exclusion of spouse in household size in calculation of protected income threshold.

Additional reductions in monthly and lifetime payments under the SAVE plan are scheduled to be implemented in July 2024.

• Reduction in monthly payment of undergraduate loan from 10 percent to 5 percent of income. Borrowers with both undergraduate and graduate loans will pay a weighted average of 5.0 percent and 10.0 percent.
• Reduction in the number of years for loan discharge based on the amount borrowed.  Current requirement for loan discharge for IDR borrowers is 20 or 25 years of repayment.  The SAVE requirements are 10 years for initial loan balance less than $12,000 and a 1- year increase for every additional $1,000 in the initial amount borrowed.

Currently, relatively few IDR borrowers receive a loan discharge as scheduled.  The SAVE rule includes new procedures designed to reduce pitfalls preventing loan discharges.  These new procedures include:

• Automatic enrollment for people who provide access to federal tax returns even without payment within 75 days.
• Access to IDR program for some borrowers in default.
• IDR credit for some borrowers in deferment but additional payments for some other borrowers in deferment.
• Some credits for borrowers in deferment.

These Biden Administration is also attempting to facilitate more existing IDR loan discharges by fixing the count of past payments on IDR loans as discussed here. The Department of Education announce of the program adjusting IDR payment counts states:

“These fixes are part of the Department’s commitment to address historical failures in the administration of the Federal student loan program in which qualifying payments made under IDR plans that should have moved borrowers closer to forgiveness were not accounted for. Borrowers are eligible for forgiveness if they have accumulated the equivalent of either 20 or 25 years of qualifying months.”

The proposed adjustment to IDR payment counts includes increase credit regardless payments plan, or existence of forbearance or deferment.  The Biden Administration projects that this initiative will provide relief to 804,000 IDR borrowers.

Evaluation of the Student Debt Initiatives:

The Department of Education claims SAVE will provide borrowers with substantial savings including:

• A reduction in total payments of 40 percent.
• A savings of $2,000 per year for a typical graduate from a four-year institution.
• A 2/3 or $17,000 reduction in total payments for a teacher using the public service loan forgiveness program.
• An 85 percent debt free rate within 10 years for community college borrowers.
• An average 50 percent reduction in total payments for Black, Hispanic, American Indian, and Native American borrowers.

Some aspects of the SAVE program are useful.  The new SAVE subsidy on interest payments when the borrower’s monthly payment does not cover interest costs will reduce costs for some borrowers.

However, the SAVE modifications do not alter basic inefficiencies with IDR loans.  

The Department of Education vastly overstates likely long-term savings from the replacement of the REPAYE program with the SAVE program.

Even with the SAVE modifications many applicants choosing the IDR loan will either pay substantially more over the lifetime of the loan than under a standard repayment plan, will pay higher taxes because of their use of the IDR option, will not receive an on-time loan discharge, or may be forced to convert to a standard repayment plan.

The SAVE program does not alter the fact that changes in earnings and changes in marital status create substantial uncertainty about the cost of IDR loans.

The decision to enter the IDR program or accept a standard 10-year or 20-year repayment plan is typically made as soon as the student borrower leaves school.  Often the applicant is single and earning a low salary.  Often the IDR program provides the only affordable payment option immediately after leaving school.

The existence of the IDR option prevents many people entering the workforce from quickly defaulting on their student debt.  Unfortunately, many of the people choosing the IDR option, because other options are not feasible will pay much more in student loans or in taxes over the life of their loan.

IDR loan payments increase substantially if income rises and/or if the person marries.  The SAVE program reduces but does not eliminate some problems caused by uncertain household income and changes in marital status.

The SAVE provision eliminating the spouse’s income in the loan payment formula for people filing separate returns will decrease loan payments for married couples filing separate returns.   However, the lower loan payment from the new rule will often be offset and could be smaller than the increased tax obligation from filing separately instead of filing jointly.

A decision to file married separately instead of filing married jointly will increase tax obligations for the vast majority of married couples, as explained here.   Features of the tax code leading to this result include:

• A substantially higher tax rate for separate returns than joint returns,
• 50 percent reduction in exemption for the alternative minimum tax,
• Loss of credits and benefits for child and dependent care expenses,
• Loss of the earned income credit,
• Loss of exclusion and credits for adoption,
• Loss of education credits and deductions, including the deduction for interest on student debt,
• Loss of exclusion on interest for savings bonds used for education,
• Potential loss of elderly tax credit or income exclusion for Social Security,
• 50 percent reduction in child tax credit, retirement savings contribution, and capital loss deduction,
• Loss of standard deduction when spouse itemizes,

There is something a bit ironic in the fact that people who decide to file separate returns to take advantage of the lower IDR loan payments could lose other education related tax benefits including the deduction of the interest on their student debt and the exclusion of tax on savings bond interest used for education expenses.

Typically, the IDR option is the only viable option for student borrowers entering the workforce because starting salaries are low.  Typically, the student borrower is single when starting repayment.  The potential problem associated with the choice between married filing jointly and married filing separately does not arise until the wedding.

The married couple that chooses to file married separately instead of married jointly to obtain a lower student debt payment, would be subject to higher marginal and average tax rates,  lose several tax deductions and credits, and pay a higher alternative minimum tax.  Most married students will choose to file joint returns and will lose the lower IDR payment and the opportunity for a loan discharge.

The projected benefits of the SAVE program offered by the Biden administration do not include the projection of a reduction in loan discharges from people who refinance their IDR loan due to increased tax obligations from changes in their marital status. 

The new rules on counting previous IDR payments and the SAVE rules designed to eliminate pitfalls preventing on-time loan discharges will prove ineffective.  

Current IDR programs have failed to provide timely debt discharges.  The existing evidence on the effectiveness of IDR loan comes from the Public Service Loan Forgiveness Loans (PSLF), which are tied to IDR loans.  Go here for some statistics.

• Around 2.15 percent of Public Service Loan Forgiveness applications processed since November 2020, were accepted.

• Only around 6.7 percent of eligible student borrowers applied for loan forgiveness.

• Around 30 percent of denied claims are due to incomplete paperwork.

There is a lot of room for improvement.  Even if the SAVE rule changes and the one-time adjustment previous IDR payment counts to lead to a large improvement in on-time loan discharges, the overwhelming majority of borrowers applying for a loan discharge will be denied.

The recent announcement is not the first announced attempt of a programs to facilitate more accurate counting of IDR loan payments.

Legislation mentioned here was enacted in 2019.

President Biden announced a previous “one-time” PSLF waiver and “one-time” IDR waiver.  The PSLF waiver lasted from October 2021 to October 2022 and the IDR waiver time frame was originally April 2022 to December 2023.   The previously announced IDR waiver described here looks identical to the one announced yesterday.

The Biden Administration claims that their new procedures will benefit over 800,000 borrowers needs to be taken with a bit of salt.  Why weren’t these borrowers already assisted by the previous one-time waiver program.

An announcement of a plan to forgive student debt is different from an announcement that student debt has been forgiven.

It would be useful to have real time information on the percent of on-time IDR loan discharges.

IDR programs require substantial paperwork including initial enrollment and annual income and household certification requirements.  Sloppiness by both borrowers and loan servicers has led to the low loan-discharge success rate. 

Many student borrowers are not highly meticulous about their finances especially when starting their careers.  

A CFPB report found that Borrowers report that servicers delay or deny access to loan forgiveness through wrong information about their loans, flawed payment processing, and bungled job certifications. 

Servicers do not have an incentive to facilitate easy on-line enrollment because they can make more money when the student borrower is slow to repay her loan.

It is difficult to audit IDR loans, since many people with low income have a zero payment, which is identical to the payment they were improperly enrolled.

Neither the “one-time” IDR payment adjustments nor the replacement of REPAYE with SAVE alters the dependence on accurate reporting by households and loan servicers.  

The proponents of SAVE can argue that their reforms will improve loan discharge rates.  

Conveniently, there will be no real evidence on this point for at least 11 years.

The SAVE program fails to reduce the amount of time for possible loan discharge for the typical student borrower completing a four-year degree program.

The loan discharge program will have a miniscule impact on the date of discharge for most four-year students.   A person with the average four-year degree debt level of $28,400 will not be eligible for debt discharge until 20 or 25 years after loan repayment begins.

The SAVE program, like other IDR loans creates unusual incentives impacting the amount borrowed and hours worked.   

In some cases, a person with IDR loans could increase the amount they borrow without increasing the amount they pay back.   This would occur when a student correctly anticipates low future earnings leading to both low loan payments and a loan discharge.  IDR loans could, therefore, encourage increased borrowing by students in fields with low earnings.

The new SAVE discharge formula will likely deter some people who complete a two-year community college program from pursuing a four-year degree.  The person with a two-year degree likely has less than $12,000 in debt and could realize a debt discharge after 10 years.  This relief would be lost if the person returns to school and take on additional debt, since under SAVE it would take the student with an average four-year debt level 20 or 25 years to become eligible for a debt discharge.

All IDR loan programs, by linking student loan payments with income, reduce funds for consumption from additional work.  The ACA premium tax credit and the progressive income tax also reduce gains from additional work.  The SAVE program reduces but does not eliminate this penalty on additional work.  (The SAVE program reduces the increase in loan payments from an increase in income from 10 percent to 5 percent.) 

Conclusion of the IDR and SAVE evaluation:

IDR programs create financial uncertainty and are inefficient.   

IDR programs do a good job in facilitating on-time payments by overextended student early in the repayment period of their loan.  

However, IDR loans have not historically been discharged on time and many IDR borrowers end up paying far more over the life of the loan, in both loan costs and taxes, than borrowers who enroll in standard repayment plans. 

The SAVE reforms do not alter many of the basic problems associated with IDR lending.

Alternative Approaches:

Modifications of the standard student loan contract: 

Three changes to current standard student loan contracts would more efficiently assist overextended student borrowers than IDR loans.  

• Elimination of interest rate for first three years on all student loans.
• Elimination of all interest rate on student debt contracts upon the maturity of the student loan.
• Convert any unpaid student loan balance to a tax obligation collected over 5 years.

Comments on proposed changes to the standard loan contract:

Comment One:  The elimination of interest charges in the first three years after initiation of repayment reduces payments at the start of the repayment process when income is typically low.

• The elimination of a 5.0 percent interest rate on a 10-year $20,000 student loan reduces monthly payments from $212 to $167.  
• The elimination of the interest charge on a $20,000 20-year loan reduces monthly interest payments from $133 to $83.

Comment Two:  When interest rates are zero, the entire monthly payment is applied towards reduction of the loan balance.  The quicker reduction in the loan balance allows student borrowers to concentrate on other financial priorities, like saving for retirement or purchasing a home, at an earlier date.  This improvement in saving opportunities for the new generation is essential to offset likely reductions in future Social Security benefits.

Comment Three:  The early interest subsidy and reduction in the loan balance facilitates, or at least does not discourage, additional study at a four-year institution by people who complete a two-year degree.  By contrast, the SAVE applicant with a two-year degree will likely lose all chance of a loan discharge after 10 years by returning to school and taking on more debt.

Comment Four:  The provision ending interest charges upon the maturity of the student loan will assist borrowers who are most likely to enter retirement and have their student loans garnished.

Comment Five:  Under the interest rate concessions proposed here, people who choose to borrow more will repay more than people who choose to borrow less.  This is not always true for IDR loan programs.  The SAVE program could increase the tendency for some student borrowers who anticipate low lifetime earnings to increase the amount they borrow.

Comment Six: The conversion of the loan to a tax obligation when interest charges are eliminated at the maturity of the loan is needed to incentivize continued loan payments in the absence of interest charges.

Modification of IDR loan contracts:

IDR loan contracts could also be modified to reduce reporting problems and increase the likelihood of at least a partial loan discharge.

• The IDR loan should require a small monthly payment even if the required payment under the IDR formula is zero.
• The IDR loan contract should provide for partial loan discharges, around 10 percent of the outstanding loan balance, starting with the completion of 24 payments. 
• An additional loan discharge of this amount would be granted after the completion of each round of 24 on-time payments.  
• The total amount of the loan discharged due to the repeated partial discharges should not exceed more than 50 percent of the initial loan balance.
• Require loan servicers create an easy on-line portal for annual updates of income and household size.

Comment One:  A zero IDR payment for a person with a zero IDR bill due to low income or forbearance is indistinguishable from a zero payment from a person who is avoiding all student loan payments.  The requirement that all people in repayment make at least a small non-zero monthly payment creates an audit trail that separates people who are attempting to pay from people avoiding their obligation.  The nominal payment would be applied both to people with a zero-payment obligation and people in forbearance.

Comment Two:  Early partial discharges will force the loan servicers and the borrower to remove pitfalls from discharge earlier rather than later, when a fix may be extremely difficult.

Comment Three:  A partial rather than a full discharge and the limitation of the total amount discharged to no more than 50 percent of the initial loan balances eliminates situations where IDR borrowers could borrow more without repaying more.

Comment Four:  Improvements in technology should facilitate greater on-time payments and fewer reporting errors.   However, these improvements may not be automatically adopted by loan servicers who often gain financially when borrowers fall behind. 

Concluding Thought: Existing IDR loan programs create substantial financial uncertainty for borrowers and are highly inefficient.  

IDR options provide borrowers with a feasible initial payment when they are starting their career at a low salary.  However, often IDR borrowers will fail to receive potential debt discharges and will pay far more both on their loan and on taxes over their lifetimes due to the selection of the IDR option.

IDR loans are in some respects similar to mortgages with teaser rates.  In the case of IDR loans, the initially affordable loan payment is followed by both higher loan payments and higher taxes.

The Biden Administration has exaggerated the potential benefits from the SAVE option, especially the likely reduction in lifetime student debt burdens.

The modifications to standard and IDR loan contracts proposed here will give a better outcome for student borrowers and taxpayers than the SAVE approach.

Student borrowers could also be assisted through changes in the bankruptcy code.

Other aspects of the student debt problem involve both the spiraling increase in tuition, living costs, and the amount of student debt incurred by the typical borrower.  

Additional discussions on proposals to assist overextended student borrowers, proposals to reduce the amount borrowed, and proposals to control college costs can be found here.

The author of this post has also written A 2024 Health Care Reform Proposal found at SellWire and at Kindle.

Introduction:

Abraham and Strain claim a debt relief proposal for student borrowers considered by President Biden is regressive.  They cite research indicating that a blanket forgiveness of $10,000 in student debt relief would offer $3.60 in debt relief to households with the highest 10 percent of income compared to $1.00 for the bottom 10 percent.  The research they cite also found that ¾ of the benefit from the proposal under consideration would flow to households with income over the median.  They argue that expansion of Income Driven Replacement (IDR) loan programs and alteration in the treatment of student debt in bankruptcy would be a more effective way to assist students with excessive student loans.

Comments on arguments advanced by Abraham and Strain:

I am not surprised that student debt does not provide much benefit to households with income in the bottom ten percent because education is the best way to avoid poverty. Most of the advantages of the current student loan discharge proposal appear to go to middle income people with income between the 25^th and 75^thpercentile.  The percent of people receiving benefits in the middle of the income distribution is a much more interesting portrayal of the equity of the proposal than the percent of benefits going to people with income over the median. 

IDR programs have proven to be ineffective at providing debt relief to student borrowers, especially middle-income borrowers.  The Public Service Loan Forgiveness loans, which are tied to IDR loans were not discharged in a timely fashion and it is likely that borrowers in long-term IDR programs will experience a similar fate.  People in IDR loan programs often can’t qualify for a home mortgage because of uncertainty about their income and loan payment. The relative merits of an IDR versus a conventional loan are unknowable immediately after the student borrower finishes school and starts repayment.  IDR loans can be negatively amortized, and many IDR borrowers pay substantially more on their loan than if they took out a conventional loan.

Abraham and Strain argue for allowing the discharge of student loans in bankruptcy, an action that would not pass Congress.  Alternatively, it would be useful to modify chapter 13 bankruptcy payment rules to allow for increased student debt payments and decreased payments on other consumer loans during the chapter 13 bankruptcy period.  This proposal also probably lacks the 60 votes needed to get through the Senate. 

Abraham and Strain argue that it is inappropriate to treat student borrowers from people who borrowed for other purposes.  However, this is exactly what current bankruptcy law does and Congress is not going to change this situation.  A second-best answer is to provide debt relief.

The $10,000 immediate student loan debt discharge strikes me as excessively generous.  I agree that it could encourage increased future borrowing.  I would structure debt relief at the greater of 20 percent of outstanding loans per year or $3,000 per borrower per year for five years.  I would exclude borrowers with household income greater than the 90^th percentile.

Concluding Remark: 

These has been a constant increase in the trend growth of the number of entrants to the workforce with student debt, the average student debt burden for new workers, and the number of older workers leaving the workforce and entering retirement with unpaid student loans. 

I understand that most people with student debt are better off than people who never went to college but increases in the burden of going to college will almost certainly increase the number of people foregoing higher education.  Congress is not going to act on this problem.  Many of the proposed solutions won’t work.  Some unilateral debt relief is the only way to avoid worsening debt burdens and increases in the number of people foregoing higher education.

David Bernstein, an economist living in Denver Colorado is the author of A 2024 Health Care Reform Proposal.  Use promotion code REFORM101 for a discount on the paper.

Student Debt Proposal #1: Eliminate First-Year Debt

The reduction of student debt taken on by first-year students through a combination of additional first-year financial assistance and restrictions on first-year loans would be an effective way to reduce total debt incurred by student borrowers.  This policy would also provide large benefits to students susceptible to payment problems because they did not finish their degree.  Go to this post for a more thorough discussion of a proposal to eliminate or substantially reduce debt incurred during the first year of college.

Student Debt Proposal #2:  Potential modifications to student loans

Existing programs designed to provide student borrowers debt relief are ineffective. Proposed reforms including — a relatively quick partial discharge of federal student loans, the elimination of interest charges on the maturity date of the loan, and the conversion of outstanding student debt at loan maturity to a tax liability collected by the IRS — would benefit both student borrowers and taxpayers.  Go here for a description of problems with existing student debt relief programs and my proposed reforms.

Student Debt Proposal #3: Facilitating on-time graduation

Students who fail to graduate on time take on high levels of student loans; hence, policies that improve on-time graduation rates would reduce student debt burdens.  There are multiple reasons why students fail to graduate on time and multiple ways to increase on-time graduation rates including — improvements in education prior to college, changes in college academic policies, and efforts to assist students dealing with hardships. Go herefor a description of polices designed to facilitate on-time graduation.

Student Debt Proposal #4: Reducing tradeoff between retirement savings & student debt repayment

Reforms centered on enhancing Roth IRAs and increasing incentives for the use of Roth IRAs would better balance saving for retirement and student debt repayment than the Secure Act 2.0 reforms that center on use of 401(k) plans. A first draft of a paper opposing the Wall Street view and suggesting new incentives can be found here. 

Coming Attractions: Forthcoming work on student debt includes — discussions of problems with public service loan programs and income based replacement loan programs, evaluation of potential regulation of private loans, the use of PLUS and parental PLUS loans, and treatment of student debt in bankruptcy.

Introduction:   Tax and financial incentives are more generous for contributions to 401(k) plans than for the repayment of student debt.

• Workers are allowed to to save untaxed dollars in a firm-sponsored retirement plan or an individual retirement account.

• Firms can match employee contributions to the 401(k) plan. Two common 401(k) matching formulas are 50 percent of the dollar amount contributed by the employee up to 6.0 percent of the employee’s salary and 100 percent of contributions up to 3 percent of the employee’s salary. 

The subsidies for 401(k) contributions are substantially higher than the subsidies for student debt repayments.

• Student borrowers can deduct up to $2,500 of interest on student loans.  

• The student loan tax deduction pertains exclusively to interest while the entire 401(k) or IRA contribution is exempt from taxes.

• There is no matching contribution for student loan repayment.

The decision to prioritize 401(k) contributions over student debt repayment does not always work out well as discussed in a previous post.  Potential consequences include:

• Higher total loan payments associated with selection of longer loan maturities.
• Higher borrowing costs stemming from higher debt levels and lower credit ratings.
• Early disbursements of 401(k) funds leading to penalty and tax payments.
• Increased likelihood of having debt obligations in retirement.

Student borrowers who quickly repay their loans would increase saving for retirement, realize lower borrowing costs, start the process of paying off their mortgage and would basically be much better off.  

There is general agreement that student debt significantly impedes saving for retirement by young households.  There is, however, no real consensus on how to fix this problem.

A Congressional Proposal:

Wall Street favors and greatly benefits from incentives for 401(k) investing.   Current proposals to assist student borrowers favored by Wall Street and financial advisors maintain incentives for 401(k) contributions over rapid repayment of student loans.

The Secure Act 2.0 would expand incentives for 401(k) contributions.  One provision would allow student borrowers who are enrolled in a firm-sponsored retirement plan to receive a matching 401(k) contribution for funds used to pay off their student loan.  

It is not clear an act of Congress is needed to implement this proposal because of a previous IRS ruling.

The proposal should allow the employer to contribute an employer match to the employee’s 401(k) plan up to the smaller of the student loan payment and the maximum allowable match on the 401(k) plan.   The student borrower repaying her loan would receive the employer match even if the student borrower did not contribute to the 401(k) plan.

The proposal only benefits student borrowers at firms with 401(k) plans, workers at firms with plans offering matching contributions, and workers eligible for the 401(k) plan.

Many student borrowers will not benefit from this provision in Secure Act 2.0 including:

• Self-employed workers and people employed by firms not offering a 401(k) plan.  Only 53 percent of small and mid-size firms offer a 401(k) plan.

• People at firms with 401(k) plans that do not match employer contributions. Around 49 percent of all firms do not offer an employer match.

• Employees who are ineligible for the firms-sponsored 401(k) plan.  Around 24 percent of firms require one year of service for entry to the firm-sponsored 401(k) plan.

• Employees eschewing 401(k) plans due to  vesting requirements.

This proposal and other aspects of Secure Act 2.0 favor higher-cost 401(k) plans over low-cost IRAS.  People who rely on high-cost 401(k) plans end up paying a substantial portion of their savings to Wall Street. Go herefor a discussion of the impact of 401(k) fees on retirement.

Moreover, the use of traditional 401(k) plans instead of Roth IRAs substantially increases tax burdens in retirement. A strong case can be made that workers should maximize the use of Roth IRAs instead of contributing to traditional plans.  

A more equitable and efficient approach might provide additional retirement subsidies for people without access to 401(k) plans or might provide additional incentives for the more rapid reduction of student loans.

An Alternative Proposal: 

The current system, which incentivizes saving for retirement over rapid repayment of student loans, does not work for many households.  This is evidenced by a CNBC article that found that nearly 60 percent of young adults have taken funds out of their 401(k) plan.

The alternative proposal presented here incentivizes the more rapid repayment of student loans over saving for retirement.  Under the alternative approach, the government would discharge 25 percent of the original balance of the federal student loan after the student borrower made 36 full-time payments on a 10-year loan and 60 full-time payments on a 20-year loan.

The alternative approach levels the incentives for rapid repayment of student debt and saving for retirement. Students who delay making full payments on their student loan would also delay receipt of the partial discharge on the student loan.  

The more rapid repayment of student loans and the partial discharge of the student loan frees up monthly payments and allows student borrowers to increase savings for other objectives including saving for retirement and a home purchase.

The alternative proposal would benefit all student borrowers including borrowers working at firms that do not have a 401(k) plan, borrowers with at firms with 401(K) plans that do not have employer matches and workers ineligible for their firm-sponsored retirement plan.

The alternative proposal does not favor high-fee 401(k) plans over low-fee IRAs.

The alternative plan does not encourage workers to stay at a job where they might be unproductive and unhappy to claim matching funds.

The partial discharge on student debt reduces demand for Income Based Replacement IBR loans and Public Service Forgiveness Loans (PSFL), both costly programs for taxpayers.

Concluding Remarks:  Wall Street and financial advisors consistently advise their clients to prioritize 401(k) contributions over rapid repayment of student debt.  This approach is not leading to a secure financial life for many student borrowers who are paying more on student debt over their lifetime, incurring high borrowing costs on other loans, having trouble qualifying for a mortgage and raiding their 401(k) plan prior to retirement.   A quick partial discharge of student debt would allow highly leveraged students to increase saving for retirement.