Five modifications to the Biden health care agenda

This post describes five policy changes, which would decrease the number of uninsured and underinsured, reduce financial exposure from high out-of-pocket medical costs, and help maintain continuous health coverage during employment transitions.

Introduction:

A previous post evaluated several of the Biden Administration’s domestic policy agendas, including the Administration’s proposals on health care and insurance, student debt and college costs, retirement savings, and the fiscal condition of Social Security.  

The evaluation of the Biden Administration’s record on health care found several persistent problems including a high number of uninsured or underinsured people, loss of insurance during economic downturns, and high levels of out-of-pocket costs leading to medical debt or decreased retirement savings have not been fully addressed.

This paper puts forward several new proposals to address these health insurance problems.

Five Health Care Proposals:

Proposal One:  Modify tax rules governing access to employer-based Insurance and state-exchange insurance:

Analysis:  Current tax rules and regulations result in around 156 million Americans obtaining health insurance through employer-based plans compared to around 16 million people who obtain health insurance through state exchanges.  The proposed changes facilitate greater use of state-exchange health insurance.  

New rules include:

  • Tax deductibility of employee benefits for 75 percent of the cost of state-exchange health insurance for each employee.
  • Modification of employer mandate to facilitate employer subsidies of state-exchange health insurance instead of firm-specific employer coverage.  All firms that pay 50 percent of employee costs on state exchanges would satisfy the employer mandate.
  • A premium tax credit similar to the existing premium tax credit to cover costs for workers without an affordable health insurance option.
  • Facilitate the purchase of retiree health insurance on state exchanges rather than through existing employer plans.

Advantages of new rules:

  • Proposal maintains tax-preferred employer payments for health insurance.
  • Proposal provides access to a wider range of state exchange policies allows workers to find a health plan that matches their needs.  Many workers with employer-based insurance have only one insurance option.
  • The use of state-exchange health plans allows workers to maintain the same health coverage during job transitions including periods of unemployment.
  • The automatic increases in the premium tax credit due to loss of income from the loss of job facilitate continuous health coverage when a worker becomes unemployed.
  • Greater use of state-exchange health insurance would make it more difficult for Republicans to initiate plans to weaken or eliminate state exchanges and other ACA innovations.

The possibility that a combination of employer-based and state exchange insurance markets facilitated through tax policy changes might lead to reduced disparities in insurance coverage and continuous coverage through job transitions was discussed here in this blog.

Proposal Two:  Modify the use-or-lose provision governing contributions to Flexible Savings Account.

Analysis: Under current rules, contributions to flexible savings accounts that are not used for qualified medical expenditures are forfeited by the taxpayer to the Treasury.  The proposed changes would allow the roll-over of unused fund to a tax-deferred retirement plan.

New Rules:  

  • Unused contributions to a flexible savings account will be automatically rolled over into either a 401(k) plan or IRA.  
  • The portion of the ACA that is rolled over into the retirement plan will be taxed as ordinary income.

Advantages:  

  • The proposal encourages greater use of flexible savings accounts, which will reduce the tendency for households to forego necessary health regimens and procedures.
  • The proposal adds additional retirement savings for workers and reduces the tradeoff between saving for retirement and savings for unanticipated health care costs.

Proposal Three: Replacement of tax deduction for contributions to a health savings account with a tax credit.

Analysis:  The current tax deductibility of contributions to health savings accounts provides greater benefits to high-income households than to low-income or middle-income households.

Potential New rules:

  • Create a tax credit equal to 20 percent of the annual contribution to a health savings account.
  • The tax credit will not be refundable.

Advantages:

  • The use of the tax credit will facilitate contributions to health savings accounts by low-income and middle-income people who are now less likely to contribute and may forego medical procedures and regimens due to lack of funds.
  • Refundable tax credits are plausible but monitoring costs would be high and Health Savings Accounts are probably not the best product for people without taxable income.

Go here for the literature on health savings accounts and high-deductible health plans.   It is possible that modification of flexible savings accounts as described in proposal two would be a more efficient approach. 

Proposal Four: Replace Short Term Health plans with a more comprehensive low-cost health insurance option.

Analysis:  Short-term health plans, which were expanded by executive order under the Trump Administration and remain in place provide suboptimal health coverage. Short term health plans often deny coverage for life-saving procedures, fail to cover many conditions including pregnancy and mental health conditions, and leave households with extremely large bills for short hospital stays. The replacement of short-term health plans with viable comprehensive health insurance would eliminate these situations.

Proposed New Rules:

  • A new health insurance product consisting of a private health insurance plan with an annual limit on total health care expenditures and automatic access to Medicaid once health expenditures reach their annual limit is created.
  • Private component of new health insurance product would be priced based on age like current state-exchange policies.
  • Private component of nee health insurance product would cover all essential health benefits like current state exchange health plans.  Reasonable deductibles and coinsurance obligations would be allowed and encouraged. 
  • Current short-term health plans which allow for underwriting based on health status, deny essential health benefits, and allow for exclusions based on previous health conditions would be prohibited.

Advantages:

  • The replacement of short-term health plans with this new low-cost private/public health option would reduce the number of people who were uninsured or underinsured.
  • The private/Medicaid option provides access to more doctors and specialists than a pure Medicaid option.
  • The private/Medicaid combination could prove to be less expensive to both federal and state taxpayers than the pure Medicaid option.
  • The premiums on the private health plan should be reasonable because of the annual limit and cost sharing obligations.  The lower premiums would reduce the loss of tax expenditures to the Treasury from government health insurance subsidies.

Go here for a short post on the problems with short-term health plans.

The idea of combining private insurance with an annual expenditure limit with automatic access to Medicaid for patients that exceeded the annual limit is conceptually similar to rules governing access to Medicaid benefits for nursing homes.  The proposal was outlined in this paper found at SSRN.

Proposal Five:  Facilitate necessary out-of-network treatments of difficult to treat conditions.

Analysis:  The passage of the Affordable Care Act (ACA) increased the need to control health care costs and insurance premiums.   Narrow network health plans are a popular option on state exchanges for people and plan sponsors seeking to reduce premium payments.  However, access to health services in narrow-network plans is often limited, especially in plans with few specialists and a narrow geographic scope. 

Proposed Reforms:

  •  Improved network adequacy regulations,
  • Expanded dispute regulation procedures to cover all medically necessary out-of-network procedures,
  • Additional government subsidies for certain high-cost medically necessary health care procedures

Advantages:

  • All three approaches have merit but the improvements in network adequacy and the expanded dispute resolution will increase costs to the insurance plan.
  • The proposal to expand existing state-level network adequacy regulations might be difficult in states with a relatively small number of providers.
  • The proposal for expanded dispute regulations procedures could be implemented through modification of the No-Surprises Act.
  • An additional limited government subsidy for high-risk high-cost cases would reduce insurance costs and premiums.

This issue could partially be addressed by expanding the No-surprises act but I argue here that additional subsidies for high-cost cases, which require an out-of-network specialists would also be beneficial.

Find more details on these policy proposals in a paper A 2024 Health Care proposal.  

An assessment of President Biden’s domestic policy record

This memo evaluates the Biden Administration’s record on policies impacting health care, student debt, retirement savings, and Social Security. The analysis presented here supports the view that progress has been limited and change is needed.


Introduction:   The Biden Administration can point to several legislative achievements and executive orders. However, actual long-term permanent progress in several areas including expansion and improvements in health coverage, reduction of student debt and the cost of college, increased incentives for retirement savings, and efforts to stabilize the Social Security and Medicare Trust funds has been small.

Health Care:

  • The number of uninsured is higher than in 2016 and will increase due to the phase out of the COVID era Medicaid extension.
  • The improvement in the state-exchange health insurance premium tax credit, enacted during the Biden Administration, is scheduled to phase out in 2025.
  • The continued high reliance on employer-based insurance will result in a rapid increase in the number of uninsured once an economic downturn occurs.
  • The long-term trend towards households having to pay an increased share of out-of-pocket health care costs persists and has not been addressed.
  • The growing use of high-deductible health plans has forced more Americans to reduce retirement savings to fund health savings accounts.
  • Many Americans remain reliant on short-term health plans, which do not insure people with pre-existing conditions, do not assure access to health care for essential health benefits, and do not protect household from large financial losses.  The Biden Administration has not rolled back the Trump-era expansion of short-term health plans.
  • Many Americans with narrow-network health plans do not have sufficient access to specialists and top hospitals.

This memo reviews some of the limitations of the Biden Administration’s health care record and proposes some modifications.

Student Debt and College Costs:

  • The one-time debt discharge proposed by the Biden Administration may not be upheld by the Supreme Court for a variety of reasons.
  • A one-time student debt discharge does not alter the trajectory towards higher student debt levels and higher college costs.
  • The payment shock from the termination of the COVID-era student loan payment freeze will reduce consumer spending and could facilitate a recession.
  • Low levels of on-time graduation remain an important factor in high student debt burdens.
  • Many student borrowers leaving school prior to the completion of a degree have a difficult time repaying their student loans.
  • The Biden Administration proposal for expanded Income-Driven loans is complex and less effective than interest rate reductions.
  • Proposals for increased assistance for students at two-year college are useful but could reduce access to four-year schools by low-income students.

Go here for a discussion of Biden-era student debt proposals.

Retirement Savings:

  • Recently enacted improvements to 401(k) plans in the Secure Act 2.0 do little to assist people at firms that do not offer a 401(k) plan.  
  • It would be useful to create an automatic savings option for workers at firms without a 401(k)-plan similar to the automatic 401(k) savings option.
  • An extremely high percentage of young adults have disbursed funds from their retirement plans early in their career.
  • Incentives for people to disburse funds in a 401(k) plan prior to retirement remain high and pre-retirement 401(k) disbursements are unlikely to fall.
  • The recently enacted automatic contribution rule may steer some workers into 401(k) plans even if a Roth IRA or some other savings vehicle is a better option. 
  • Many 401(k) plans have limited investment options and high administrative fees. 

This essay  describes ideas on how to expand private retirement savings and deal with the impending short falls in the Social Security and Medicare trust funds.

Go here for more details on why IRAs should be expanded.

Recent legislation on private retirement savings described here appears to do more for the investment industry than for savers.

Social Security:

  • A high percent of workers nearing retirement with low levels of retirement savings will be highly dependent on Social Security during retirement.
  • Projected shortfalls in the Medicare and Social Security trust funds would lead to automatic benefit cuts in 2031 and 2033 respectively under current law.
  • No one in Congress is working on a bipartisan solution to the impending Social Security and Medicare trust fund shortfalls.

This memo describes the linkage between Social Security reform and efforts to expand private retirement savings.  Work summarizing different Social Security reform proposal will be available shortly.

Concluding Remarks:  The case for renominating Biden largely hinges on the view that the President is the best candidate to defeat former President Trump.  However, as discussed here I do not believe former President Trump will be the Republican nominee in 2024 and President Biden does not match up well against a younger Republican challenger, especially one willing to break away from parts of the Trump agenda.

The 2024 election should be about how we move forward as a nation.  A candidate should talk about how issues like how we can change insurance rules so people don’t lose their health insurance during job transitions, how we can lower student debt burdens for the people who are most likely to experience payment problems, how we can assist workers in saving more for their retirement and how we can improve the financial condition of entitlement trust funds prior to the implementation of automatic benefit cuts.  I have reached the conclusion that Governor Whitmer or Governor Inslee are better able to move the country forward on these issues than our current president.

2024 Insights: Trump will not be the Republican nominee

Early national polls of Republican voters mean zilch. Some states have open primaries and a smaller field that narrows quickly can quickly settle on someone other than Trump.

The national media believes that Trump is the clear favorite for the Republican nomination.  My view is that the likelihood of Trump winning this nomination is around 25 percent.  

Some observations supporting the emergence of an alternative to Trump:

People always assume the previous race will look like the last one.  In the 2016 Republican contest there were 17 major candidates and the field narrowed slowly.  This time around there may be a total of 6 candidates with field narrowing to 3 after New Hampshire. 

Many states have open primaries, which allow voters to enter the primary of their choice. Most independents have an unfavorable view of Trump.  Many independents will participate in an open Republican contest and vote against Trump If Biden is not challenged in the Democratic contest.  Three of the early crucial contests, Iowa, New Hampshire, and South Carolina are open contests.

Iowa, the first caucus, is likely to be a muddle.  The Iowa Republican caucus often goes to a candidate with regional ties or fervent anti-abortion views.  The Democrats have moved Iowa to a later date, a change that will likely cause more independent voters to caucus with Republicans.

Two key early states, New Hampshire and South Carolina have open primaries.  It is conceivable that Trump loses both primaries and gets knocked down early.  Chris Sununu, the governor of New Hampshire, would win the New Hampshire contest if he enters.  Whether Trump could rebound in South Carolina depends on how quickly the field winnows.

Concluding Thought:  Biden fares poorly in a general election race against Sununu.  Whitmer would be a much stronger candidate. Future election posts will examine the contest or lack of contest in the Democratic party and factors impacting the general election.

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An analysis of fiscal policy under a debt limit

The economic consequences of a default on the national debt would be catastrophic to the nation and the world economy. The debt-limit dispute has forestalled discussion of rational budget changes and entitlement reform. President Biden has the legal authority to ignore the debt limit and pay the nations bills. House Republicans have many other ways to pursue their agenda.


Introduction:  

The current standoff over the debt limit between House Speaker McCarthy and President Biden reminds me of the line in the movie Cool Hand Luke “What we have here is a failure to communicate.”

The Speaker’s position is that there will be no increase in the debt limit without substantial reductions in spending.

The President has refused to negotiate over the debt limit and would deal with Congressional efforts to trim the budget through the normal appropriation process.

This post evaluates the debt limit conflict.

The status of debt-limit proposals:

The Speaker of the House has taken the position that he will not support an increase in the debt limit unless it is accompanied by substantial reductions in spending.  House Republicans differ on the type of spending cuts they support.  Many of the cuts in a House bill would not pass the Senate.

The current House Republican proposal discussed here contains the following items:

  • An increase in the debt limit by $1.5 trillion or until March 2024, whichever comes first,
  • Cancellation of the Biden Administration student debt discharge proposal,
  • The reinstatement of student loan payments, halted by executive order during the COVID pandemic,
  • Prevention of the enactment of changes to Income Driven Loan plans,
  • Rescission of newly appropriated IRS funds,
  • Creation of a work requirement for federal assistance programs including SNAP and Medicaid,
  • Elimination of tax credits for electric vehicles and other solar and wind projects enacted in the Inflation Reduction Act,
  • Reduction in funding from 2024 levels to 2022 levels and a limitation of annual funding increases to 1.0 percent.

Several aspects of the debt-limit dispute are examined here in more detail.

Concern One: Economic Issues

 A debt default by the United State is an existential threat to the national and world economy

  • Federal benefits including Social Security and Medicare and Medicaid payments would be disrupted.
  • Substantial amount of world trade, which is denominated in dollars would be disrupted.
  • Investors would dump Treasury securities and interest rates would rise.  
  • The stock market would fall drastically.
  • The duration of the stock market decline and interest rate spike would depend on duration of default.
  • The dollar would likely lose its status as world’s reserve currency.
  • Recession and stagflation would likely ensue.
  • Assistance to Ukraine would be disrupted.

Concern Two:  Legal and Constitutional Issues

Legal experts differ on the ability of the President to pay bills, maintain benefits, and raise new funds should Congress fail to increase the debt limit.

  • The founders of our nation did not envision a situation where one part of a divided Congress could dictate massive policy changes to the other part of Congress and the Executive.
  • Many legal scholars believe the President has the authority to ignore the debt limit when congressional actions create unconstitutional doubt about the validity of the public debt.  See this note.
  • Congressional Republicans have many levers including the normal appropriation process, court action, government closure to reduce spending.
  • Supreme Court should stay out of this dispute between Congress and the President.  Congressional Republicans have an impeachment option if they believe the President’s actions are illegal.

Concern Three:  Fiscal and Budgetary Issues

Many items in the Republican agenda are severe and have little support in the Senate.  However, some items have merit and could be enacted in a different political environment.

  • The simultaneous enactment of the Republican fiscal agenda with Federal Reserve monetary tightening would result in a severe recession.
  • Fiscal policy is already becoming more stringent because of the end of COVID relief programs and automatic phaseouts of some programs.
  • The COVID-era Medicaid expansion has lapsed.  Go here for a discussion of the impact of the end of this benefit.  Additional Medicaid work requirements would further increase the number of uninsured.
  • The current proposal does not appear to target the ACA.  However, the elimination of the ACA subsidy cliff automatically phases out in 2025.
  • A strong case could be made for modification of the EV tax credits, which I have argued  here are regressive and a costly way to motivate more rapid introduction of EVs.
  • The Biden Administration student discharge proposal is not clearly connected to the COVID pandemic and could be eliminated by litigation currently before the Supreme Court.  The Biden Administration and Congress should consider revisions to student debt programs described here.
  • The reduction of SNAP programs would substantially increase hunger in America.
  • The limitation of future expenditures to an annual increase of 1.0 percent is problematic given that inflation remains above 5.0 percent.
  • The proposed recission of funds for the IRS would increase budget deficits.
  • The proposed reinstatement of the debt limit prior to the election is a political non-starter.
  • The debt-limit threat has caused the Administration to delay replenishment of the strategic petroleum reserve.

Concern Four:  The Role of Entitlements

The current budget debate ignores key issues pertaining to the future of Social Security and Medicare.  This is a huge mistake.

  • The trustees of the Social Security Trust fund project that declines in Trust fund assets will trigger automatic Medicare benefit cuts in 2028 and automatic cuts to Social Security in 2033.  Go here for part of this discussion.
  • The existence of a debt-limit dispute in a year where the Trust Fund balance dictates automatic reductions in either Medicare or Social Security benefits ncreases the likelihood of benefit reductions.
  • The delay in the entitlement discussion could result in abrupt entitlement benefits in the future.  Go herefor a discussion of why changes to Social Security need to be phased in slowly and coupled with improvements to private retirement savings.

The decision by both the Republicans and the Democrats to delay discussion of entitlement reforms increases the likelihood that the reform process will result in a less than optimal outcome.

Concluding Remarks:  Down-to-the-wire disputes over the debt limit are never good for the economy, for the markets and are not an effective way to deal with increased debt levels or wasteful spending.  Government closures also aren’t good for the country, but the economic consequences of a government closure are infinitely less drastic than a default on the debt.  

President Biden must make clear that the debt default is not going to happen.  The only way for the President to remove the uncertainty of a debt default is to announce that he will ignore the debt limit and pay the nation’s bills, an action supported by many legal scholars.

An evaluation of efforts to expand use of electric vehicles

Biden administration efforts to speed the adoption of electric vehicles (EVs) while well intended, are expensive and will likly prove ineffective. A better result could be achieved through a revenue neutral tax reform, which raises the relative cost of conventional vehicles to EVs.

Introduction:  The Biden Administration has placed a high priority on the more rapid introduction of electric vehicles. Policy initiatives include a first round of grants for states and communities to build EV charging stations,  extended tax credits for the purchase of EVs enacted in the Inflation Adjustment Act, and substantial increases in emission standards, like rules adopted in California, to boost EV sales.

These policies, while well intended, comes at a high economic cost and result in adverse environmental consequences.

Some problems with efforts to spur the growth of Electric Vehicles:

Budgetary impacts: The official forecasts of the cost of the EV tax credit to the Treasury does not correspond with forecasted EV sales growth.  A forecast used by the Joint Committee on Tax assumes the sale of 4.1 million plug-in vehicles over a decade.  By contrast, the new emissions standards proposed by the Biden Administration would result in EVs becoming two thirds of all new car sales, around 11 million annually.  Hence, the loss in tax revenue from the EV credit in a single year could be substantially larger than the projected loss for a decade.

A tax credit for the sale of a used EVs is more cost-effective than the tax credit for new EVs.  However, all direct consumer subsidies are expensive and difficult to justify given budget deficits and competing needs for funds.

A regressive subsidy:  EVs are currently an expensive luxury item sold primarily to affluent people.  In 2022, the average price of an EV, around $61k was around 25 percent higher than the average price of a conventional car.  Around 57 percent of EV buyers had income greater than $100k.  Even though the tax code prevents people with high income from claiming the EV credit, most recipients of the credit are affluent and the subsidy itself is a regressive policy. 

Issues associated with lithium:  The supply and cost of EVs will be impacted by the scarcity of lithium, the key ingredient in EV batteries.  China controls 70 percent of global lithium production.  Currently, lithium prices have fallen because of lack of demand in China but that will reverse when production in China resumes.  A new lithium mine being created in Nevada may reduce prices but lithium mining results in adverse environmental impacts including damage to soil, water and air.

Is EV growth inflationary? A shift in demand from conventional cars to EVs will increase the cost of living because EVs are more expensive than conventional cars.  The shift will be inflationary even if the price of EVs falls somewhat.  The BLS could claim EVs are an improved product and part of the price differential could be excluded from the official Consumer Price Index calculation.  However, EVs have a smaller driving range than conventional vehicles; hence, any adjustment to the CPI because of product improvement will be small.  Go here for a discussion on how the BLS adjusts prices in the CPI for changes in quality.

The cost of fueling an EV is substantially smaller than the cost of fueling a conventional vehicle a clear cost reduction.

The cost of insurance on an EV is higher than the cost of insurance on a conventional vehicle since insurance costs are tied to the value of the vehicle.  The savings in fuel costs will likely be smaller than the additional insurance costs.

The EV tax credit was included in the Inflation Adjustment Act, in my mind a misnomer.  A more accurate description of the law might be the Inflation Mitigation Act.

Impact on Traditional Hybrid Vehicles:  Traditional hybrid vehicles, which rely on an internal combustion engine and do not use a plug to charge, do not receive a tax credit.  The Prius gets over 50 mpg, both in the city and on the highway while non-hybrid vehicles like the Corolla get around 30 mpg.  The starting MSRP for a Corolla is around $21k compared to the starting MSRP of a Prius of around $28k.  A small tax incentive designed to motivates purchases of traditional hybrids over non-hybrids would substantially reduce carbon emissions in a cost-effect manner.  Furthermore, if the EV tax credit causes some consumers to choose an EV over a Prius, the environmental gains from this proposal will be small.  The EV tax credit is a slap in the face to Prius owners.

Uncertain consumer demand and the emissions standard:  The proposed emission standards set a target for the emissions of the entire fleet sold by a manufacturer in the year. However, the demand for EVs may be less than anticipated leaving the manufacturer short of the emissions target or in a position where the automobile firm must sell EVs at a loss to meet the target.  

Impact of new small inexpensive hybrids:  This article on the proposed emission standard indicates most growth in the EV market will be among small vehicles.  Automakers are now introducing a $25k EV, substantially lower than the average new-care price.  However, a bare-bones small EV costing $25k could be substantially more expensive than a bare-bones small conventional vehicle.  The substitution of a bare-bones EV for a bare-bones conventional vehicle may increase costs for the consumer and have a relatively small environmental benefit.

Impact on the used-car market: Despite the tax credit and the regulations, many people, especially older consumers will resist switching to EVs.  This will cause them to hold onto their vehicles longer and will result in higher used-car prices.  The increase in the lifespan of existing conventional vehicles will reduce improvements in fuel efficiency and carbon emissions, at least temporarily offsetting environmental benefits of the new EVs.

An Alternative Approach:

The most troubling problem with the use of the EV tax incentive is the potentially large impact on the Treasury.  The most cost-effective way to achieve an environmental objective involves the use of the tax code to favor the item that pollutes less over the item that pollutes more.  In my view, it is difficult to justify direct expenditures subsidizing the purchase of personal vehicles when there are large funding needs for other priorities including, improvements in health insurance and expanded private retirement savings.

The EV market could be promoted without a loss of tax revenue through a revenue neutral tax change designed to alter the relative cost of owning EVs and conventional vehicles.  

One approach would involve combining an annual fee for the use of conventional vehicles with an increase in the standard deduction or more generous tax credits for funding a health savings account or an Individual Retirement Account.

The case for modifying Biden’s Student Debt Discharge Proposal

President Biden’s student debt discharge proposal is not the most effective way to mitigate student debt problems associated with COVID. This post examines issues associated with the Biden Administration student debt discharge proposal and proposes an alternative executive order.


Introduction:  The student debt discharge proposal crafted by the Biden Administration is in trouble.  

It is currently being challenged before the Supreme Court and in Congress.  

The connection of the student debt discharge proposal with the COVID pandemic is tenuous at best. The conservative court is likely to rule that the President does not have the authority to provide debt relief in this form.   A ruling against the Administration on this proposal could expand the type of federal regulations subject to challenges.

The GAO has ruled that the Biden Administration’s student debt discharge proposal is subject to the Congressional Review Act, which allows Congress to overturn government agency rules by majority vote.  A bill currently in Congress could eliminate the student debt discharge program; although President Biden will likely veto this bill if it passes Congress.

The additional debt stemming from failure to reinstate some payments on student loans will also increase the national debt and exacerbate issues related to the debt limit dispute.  Congressional Republicans may link the student debt discharge proposal to the debt limit debate.  

The Biden Administration will find itself in the uncomfortable situation of having to defend an executive order that reduces revenue when Congress is refusing to increase the debt limit, an action that could lead to a catastrophic default. 

Clearly, Congress is responsible for all debt incurred from past spending and tax decisions.  However, the Biden Administration student debt discharge plan was not explicitly approved by Congress.  

These economic, legal and political problems can be resolved by replacing the current student debt discharge proposal with a modified program that is more closely linked to payment problems caused by the COVID pandemic.

Background on the Biden Student Debt Discharge Proposal:

The Biden Administration is proposing a one-time discharge of federal student debt.  Borrowers with a Pell grant can have up to $20,000 discharged.  Borrowers without a Pell grant can receive a discharge up to $10,000.

Taxpayers with income less than $125,000 (single filers) or $250,000 (married filers) are eligible for the one-time debt discharge.

Student loans taken out after June 20, 2022, are not eligible for the loan discharge program.

Six states have brought litigation to stop the Biden Administration student discharge program on grounds that the Biden Administration exceeded their legal authority and that the law damages institutions in their state.  The Biden Administration claims their authority to provide student loan debt relief due to COVID stems from the 2003 Heroes Act which allows for relief under a national emergency and that the plaintiffs do not have standing to litigate this issue. 

Many people question the connection between the proposed student debt discharge and the COVID emergency which created the rationale for the proposed discharge.  Some people will have all of their debt discharged, far more than is necessary to deal with problems caused by the COVID pandemic and the payment shock from the reinstatement of payment obligations.

The COVID pandemic has largely ended in the United States and most program designed to assist people because of COVID, including additional food stamps, housing assistance, expanded access to Medicaid, and free vaccines, have ended or are ending.  

Motivating student debt relief because of the COVID emergency: 

The COVID emergency has exacerbated two problems associated with student debt.

First, the restart of loan payments creates payment shock for many households at a time when interest rates are rising, and many prognosticators believe the economy is heading towards a recession.  A limited temporary revision to student loan contracts could address problems to the economy caused by the payment shock.

Second, most borrowers have a higher outstanding student loan balance because of the student debt payment freeze.  A non-trivial portion of these borrowers are older and either nearing their last decade in the workforce or nearing retirement.  The growth of the number of older Americans with retired student loans is a growing problem, which appears to have been exacerbated by the payment freeze.  A limited temporary revision to student loan contracts could address problems caused by the higher outstanding loan balances stemming from the student loan payment freeze.

Any emergency student debt relief proposal that is consistent with efforts to mitigate problems associated with the COVID pandemic should be tailored to address those problems in a cost-effective manner.  A one-time debt discharge of up to $20,000 is not a cost-effective solution to these COVID era problems.

An alternative student debt relief plan:

The alternative student debt relief plan presented here offers a 0 percent interest rate on federal student debt up to a balance of $30,000 for a period of five years. 

The alternative student debt relief plan could also include a loan discharge of 10 percent of each on-time monthly payment.

A new executive order replacing the current debt discharge proposal with these modifications to the student loan contract would address the problems caused by payment shock and the the increase in borrowers nearing retirement with large outstanding student loan balances.

This interest rate reduction is a cost-effective way to reduce payment shock from the return of student debt payment obligations.

The reduction of the interest rate from 5.0 percent to 0.0 percent on a 10-year $30,000 student loan would reduce monthly payments from $318 to $250, approximately a 21 percent decrease in monthly payments. The reduced payments over five years add up to $4,092.

The additional 10 percent discharge applied only when payments were made on time could reduce debt by an additional $409 dollars.

The 10 percent discharge and a late fee when payments are not made on time would incentivize student borrowers to make payments on time, even though the interest rate on the loan was set to zero.

Concluding Remarks:  The interest rate reduction and partial debt discharge described here incentivizes student borrowers to repay their loans.  The receipt of loan payment by the Treasury will reduce the national debt over time compared to the Biden Administration discharge proposal and compared to the current freeze on payments.

Linking Social Security reform with Private Saving Reform

Increases in the eligibility age for Social Security benefits need to be phased in slowly to prevent financial shocks to households nearing retirement and coupled with new policies that increase savings by younger adults. This post considers how a gradual change in Social Security benefits could be attached to proposals that promote increased private saving.


Introduction:  One approach being considered to expand the lifespan of the Social Security Trust fund involves increases in the eligibility age for receipt of the minimum and full retirement benefit.  This approach would result in substantial improvements in the financial condition of the Trust fund.  It would both increase revenue by forcing people to work longer and would delay outflows from the Trust fund.  It would reduce the future debt to GDP ratio and reduce the likelihood of future increases in taxes to pay off debt.  

However, there are adverse impacts and limitations associated with increases in the eligibility age for Social Security benefits.

First, most current retirees are highly dependent on Social Security.  (A study based on data from the Current Population Survey reveals 52 percent of older households receive more than half of their income from Social Security and a third receive more than 75 percent of income from Social Security.)  Workers currently nearing retirement could not be expected to substantially increase their savings to prepare for the increased retirement age. 

Second, A phased in increase in the retirement age would not prevent project automatic reductions in Social Security benefits associated with reduced Trust fund reserves.

Third, many workers when they near the eligibility age for Social Security benefits need to retire or need to reduce the hours, they work because of health concerns.  Health related problems impacting older workers will impact both current workers nearing retirement and future cohorts of workers. 

Fourth, younger adults are having an extremely hard time saving for retirement.  Student debt is at a record level and continues to climb with college cost and many young adults with high student debt burdens are either delaying saving for retirement or disbursing funds in retirement accounts early in their careers to meet current obligations.  A discussion of the use of pre-retirement funds prior to retirement can be found here.  In addition, young workers must save more for retirement than previous retirees because they are less likely to have access to a traditional defined benefit pension plan.

Changes to Social Security retirement benefit formulas need to be implemented gradually to avoid an abrupt economic shock impacting people nearing retirement and need to be linked with changes in savings incentives and economic reforms which facilitate increased private savings for retirement.

Increasing the eligibility age for Social Security Benefits:  Under current law, workers initially become eligible to claim Social Security retirement benefits at age 62.  People born after 1960 are eligible for the full Social Security retirement benefit at age 67.  The largest possible Social Security benefit is received by people who delay claiming until 70.

Changes to three parameters – the initial eligibility age for Social Security benefits, the eligibility age for the full benefit, and the age where people receive the maximum allowable benefit – are considered here.  The proposed changes would start five years after enactment after legislation.  The three retirement age parameters would increase by one month every two years until all three retirement ages increased by two years.  After the full enactment of the increased retirement age, the minimum eligibility age would be 64, the age of full benefits would be 69 and the age of the maximum benefit would be 72.

When the Social Security eligibility age is phased in many recipients will receive two fewer years of benefits over their lifetime.  

The phased in benefit reductions put the United States on a more favorable and sounder fiscal trajectory. These benefit reductions will reduce the future debt to GDP ratio.  However, the phased in adjustments do not prevent the automatic reductions in Social Security, which are current projected to occur in 2034.  The prevention of the automatic benefit cuts requires some other action by Congress.

One approach to deal with the automatic benefit cuts would involve the use of general tax revenue, which would lead to higher annual budgets. The projected future debt to GDP ratio is a more important measure of fiscal health than annual budget deficits because markets are forward looking, hence the prospect of lower future debt levels will restrain interest rates even if deficits rise in the short term.

The avoidance of projected automatic cuts to Social Security will also require some additional revenue from an increase in the payroll tax or some other tax.

The phase in of these changes would have to be slow to avoid financial shocks on people nearing retirement and to allow for increased private savings. The slow phase of the benefit changes allows for people to increase retirement savings prior to retirement. Younger adults will experience the full brunt of the change in the Social Security eligibility change but will also have more time to take advantage of reforms that will facilitate increased private savings.

Facilitating increased private savings:  Since most households nearing retirement age will be highly dependent on Social Security and most younger households have either delayed or reduced saving for retirement to meet current needs the proposed increase in the eligibility age for Social Security benefits must be accompanied by policies that lead to increased savings for retirement. 

The first set of policy proposals involves direct improvements to savings incentives and investment vehicles offered by investment firms.  The proposed changes in tax incentives and financial rules favor households which are currently having a difficult time saving for retirement, including people without access to the most generous employer-sponsored and people reducing retirement savings because of medical expenses.  The new tax and financial rules will provide incentives for workers to start saving for retirement at a younger age.

 Modifications to Direct Savings Incentives and Rules:

Tax and pension rules should be changed to equalize savings opportunities for workers dependent IRAs and 401(k) plans. 

  • Currently, higher income taxpayers will receive a higher tax savings from a 401(k) contribution than a low-income taxpayer.  This disparity would be eliminated by replacing the tax credit for contributions to retirement plans with a tax credit.
  • Current tax law allows employers to match employee contributions to 401(k) plans but does not allow for matching contributions to IRAs.  The rules should be changed to allow employers to contribute match employee contributions to IRAs as well as to 401(k) plans.
  • Tax law could be changed to allow firms to provide tax free contributions to retirement accounts of gig employees.  
  • Current limits on employee contributions to IRAs are lower than contributions to 401(k) plans.  These contribution limits should be equalized.

Improve the automatic 401(k) enrollment option and create a similar automatic savings option for firms that do not offer a 401(k) plan.  

  • The newly enacted automatic 401(k) enrollment option allows for firms to automatically enroll workers in 401(K) plans that charge high fees or have few investment opportunities.  The government could improve investment outcomes and increase wealth at retirement by limiting fees and by requiring access to low-cost or zero-cost investment options like direct investments in Treasury securities.
  • Automatic enrollment into IRAs or savings through Series I savings bonds should be created for workers employed at firms without a 401(k) plan.  The new automatic enrollment provision would be patterned after the 401(k) automatic enrollment provision, which allows workers to opt out of the automatic contribution and sets the initial contribution at 3 percent of income.  The expanded automatic enrollment provisions create an incentive for younger adults to either open an IRA or some other savings vehicle.  (Most young workers do not have access to a firm-sponsored retirement plan or are subject to vesting requirements.)   The initiation of saving at a younger age is a crucial reform needed to assure increased wealth at retirement.

Create rules that prevent use of all retirement fund prior to retirement and encourage workers to reduce leakages of funds from retirement accounts.

  • Current tax laws allow for investors to disburse all savings from a 401(k) plan or IRA prior to retirement.  (Disbursement rules are complex and often involve payment of tax and penalty.)  A new rule might prohibit pre-retirement disbursements greater than a certain percent of contributions, perhaps 50 percent of contributions.
  • Many young workers automatically disburse all funds contributed to a retirement plan at their first permanent job.  The default option for 401(k) funds during job transfers should be automatic transfer to a low-fee independent account. The worker who wants to maintain retirement savings at her old employer or withdrawing funds from an existing account would have the option of opting out of default arrangement.

Modify tax rules governing Flexible Savings Accounts (FSAs) and Health Saving Accounts to allow for increased savings.

  • Current rules governing FSAs result in the FSA owner losing any unused funds in the account at the end of the year.  A change in FSA rules that allows unused FSA funds to be rolled over into a 401(k) or an IRA would encourage greater contributions to FSA accounts and increase retirement savings.
  • Current rules only allow people with qualified high deductible health insurance plans to contribute funds to a health savings account. A change in these rules to allow for health savings account contributions for people with a wider variety of accounts could expand savings for health care and for retirement.   The new rule could lower rate of depletion of funds in the health savings account or increase contributions to retirement accounts since health savings accounts are often funded by decreased contributions to retirement accounts.

Expand investment opportunities in 401(k) and 529 college savings plans to allow for direct investment in Treasury securities including Series I Savings bonds and the tax-free conversion of 529 assets to 401(k) plans:

  • Many retirement plans and virtually all College Savings 529 plans allow for investments in a few fixed-income and equity funds and do not allow for workers to purchase bonds with a specific maturity date.   These bond funds, even those with short maturity assets fall in value when interest rates rise.  Investors should be given the option of holding Treasury securities to maturity when they will be guaranteed access to the initial bond purchase and all interest.
  • Rules should require retirement plans to provide access to all Treasury bonds including Series I bonds and Treasury Inflation Protected Securities (TIPs).  Access to these investments would reduce loss of wealth from fees and reduce portfolio risk.  
  • Current law taxes disbursements from 529 plans not used for educational purchases.  Workers should be allowed to convert part of the unused 529 plans to a 401(k or IRA without paying tax.  (Typically, the 529 contribution is exempt for state tax but not exempt from federal tax.  Since the initial contribution to the 529 plan was subject to federal tax the loss of federal tax revenue from this proposal might be modest.) 

Removal of Impediments to Saving for Retirement:

Many people fail to save for retirement because they get caught in a spiral of debt and live paycheck to paycheck for a prolonged period.  Often young adults delay saving for retirement or even raid their retirement plan to maintain their student debt payments. Roughly 9 million borrowers over the age of 50 are still making payments on their federal student loans and are having trouble meeting expenses in retirement.  

Other households, especially people with employer-based health insurance often lose health insurance during job transitions.  A loss of health coverage and increased medical debt exacerbating disruptions in the process of savings for retirement routinely occur during recessions.  

A second set of policy initiatives attempts to remove impediments to saving experienced by people who have high student debt or lose health insurance during job transitions.

Implement policies to reduce student debt burdens to facilitate increased savings for retirement.

  • Many of the most vulnerable student borrowers that have difficulty both repaying their student debt and saving are people who borrow but never complete their degree.  The number of households in this situation could be drastically reduced by the implementation of policies that reduce or eliminate debt by first-year students.  The elimination of first-year student debt would also reduce average student debt burdens for all students with debt.  This proposal is far less expensive than the Sanders program to eliminate all college debt at public universities. 
  • Currently student borrowers must choose between a standard student loan contract and an Income Driven Loan (IDR) program as soon as they start loan repayment. In some instances, people who chose the IDR program paid more on their loan over the lifetime of the loan or failed to get the timely debt discharge as promised.  The standard loan contract does not offer the possibility of a loan discharge even if the borrower has low income in the future.   These problems can be mitigated by a modification of the standard student loan contract to include the elimination of all interest charges combined with accelerated repayment obligations 10 years after the initiation of repayment.

Modify rules governing tax incentives for employer-based health insurance and state exchange health insurance to allow for reduced loss of health insurance during economic downturns

  • The proposed solution to discontinuities in insurance coverage stemming from changes in employment involve – a rule change allowing employer subsidies of state-exchange insurance instead of employer-based insurance, the automatic conversion of employer-based insurance to state exchange insurance when employees are laid off, and a modification of the premium tax credit for state exchange insurance. More information on this proposal and other health care reforms can be found here.

New Political and Economic Dynamics:  The current political debate on Social Security involves proposals to either cut benefits or increase taxes and ignores problems caused by disparities in private retirement savings.

Any change to an inter-generational program must be phased in slowly to avoid political and economic turmoil.

However, most young adults would be unable to substantially increase their savings rate given current savings incentives or high debt burdens.

A higher eligibility age for Social Security benefits must be accompanied by reforms designed to reduce disparities in private savings.  These reforms will reduce the dependence of future generations on the Social Security program.

Many of the improvements in savings incentives, reductions in student debt and improvements to health insurance proposed here, are unaffordable if not accompanied by substantial new revenue or budget cuts.

Increases in retirement savings require changes in retirement plan rules and procedures.  Many current rules favor Wall Street over investors and tie investors into expensive products offering suboptimal returns or high levels of risk.

Social Security reform and private savings reform are intrinsically linked.

The proposals presented here would reduce wealth inequality and will improve the fiscal condition of the nation, truly a rare combination.

Comments on the SVP debacle

High interest rates did not cause the SVB collapse because interest rates remain below their historic average. Management of SVB and possibly other banks failed to implement their core responsibility – matching the duration of assets and liabilities. Efforts to deal with bank insolvencies will lead to higher and more prolonged inflation.


Prologue:  In 1991, the Treasury Department reviewed potential risks to the financial stability of Fannie Mae and Freddie Mac.  A government model had concluded that the companies would not face problems due to an increase in interest rates until rates rose to the 24 percent or 28 percent level.  

My review of this model found that the model understated interest rate risks for two reasons.  First, the model omitted information about annual and lifetime payment caps on Adjustable-Rate Mortgages, which reduce bank revenue when interest rates rise.  Second, the model did not fully consider the impact of interest rates on defaults and other outcomes that could exacerbate financial stress when interest rates rose.  

A revised version of the government model that I put together concluded an interest rate shock in the 12-14 percent range would lead to financial problems for the two companies.  Treasury officials were grateful for this input but were largely unconcerned because interest rates were on a downward trajectory.

The current generation of management at many banks takes extremely low interest rates for granted and understates risk associated, which exist when the duration of their asserts do not match the duration of their liabilities.

The 10-year Treasury interest rate a couple of years prior to the 2008 insolvency of Freddie Mac and Fannie Mae was around 5 percent, far lower than the interest rates that prevailed in most of the 1990s.

The 10-year interest rate at the time of the SVB debacle was around 4.0 percent and is now at 3.7 percent, below its historic average.

Comments

Comment One:  Don’t blame the Fed or high interest rates for this debacle.  High interest rates did not cause the SVP collapse because interest rates are not high as discussed in the post Should the Fed Pivot?

Comment Two:  It is hard to understand why anyone, let alone a sophisticated financial institution with short term obligations, would tie up funds in long-term bonds when the yield on the 10-year government bond was lower than 1.0 percent during the pandemic and remains below the long-term average. More information on the type of investments that lead to this debacle is needed. Note, even short-term bond ETFs invested in inflation protection bonds like VIPSX, VTIP, and STIP, have lost substantial value in the past year. Go herefor a discussion a discussion of use of bond ETFs in a low interest environment. The collapse of a bank due to an interest rate exposure when the 10-year bond yield remained at 4.5 percent could have occurred if the bank’s analysts had grossly miscalculated the impact of interest rates on certain assets.

 Bank officials purchasing these bonds and bond funds should have more carefully researched the impact of interest rates on all of their investments and realized there was more downside risk than upside potential from investing in fixed income assets when interest rates were at such a low

Comment Three:  SVP may be the canary in the coal mine.  The insolvencies of Freddie Mac and Fannie Mae were preceded by insolvencies of some smaller private mortgage insurers. The SVB closure occurred very quickly after the public became aware of the problems at the bank because there was a run for deposits.  The First Republic Bank, is now losing deposits.  Transparency causes depositors to flee but is necessary to assure better investments.

Comment Four:  Regulators need to actively monitor a second potential stress point — crypto Ponzi schemes like the ones at FTX and Silvergate.  Did crypto play a role in the SVB debacle? I wonder what impact if any exposure to crypto had on the SVB collapse.

Comment Five:  The CEO of SVB sold $3.5 million in stocks prior to the sale of the bank.  Federal regulators should move to claw back the proceeds of this gain.

Comment Six:  The blame game has started.  Republicans are blaming lax fiscal and monetary policy and have conveniently ignored their role.  Yes, Jerome Powell should have increased interest rates sooner.  However, there is a lot blame to be shared here.  The Trump era tax cuts and Trump’s threats to fire Chairman Powell if he did not lower interest rates had a major impact on the nation’s fiscal and monetary condition.  Also, Republicans have consistently argued for less regulation, a position that is hard to defend.   

Comment Seven:  The Fed is now in a tight box.  Inflation and the labor market remain robust.  A move by the Fed to prevent insolvencies, by lowering the cost of credit or by purchasing some of the long-term bonds owned by SVB, will lead to more inflation.  Bill Ackman is making the case that SVB is too big to fail and the Fed should consider some sort of bailout.   Dealing with the banking crisis could lead to higher inflation over a prolonged period.

The Choice Between Fixed Income Funds and Direct Purchases of Bonds

Whenever possible investors should seek out tax-preferred savings vehicles, which allow for direct investments into Treasury securities and hold Treasury bonds and notes instead of fixed-income funds. People saving for retirement or higher education can minimize risk by matching future obligations with specific bonds.


Introduction:

Many tax-preferred retirement accounts and 529 funds restrict investment choices to a small set of stock and bond ETFs or mutual funds.  The allowable investments inside a 401(k) plan are selected by the plans sponsor. For example, the Thrift Savings Plan (TSP) offered to federal employees has several funds and an option for mutual fund investing but does not allow workers to purchase Treasury Securities directly through the Treasury or through a broker.

Most individual retirement accounts (IRAs) and brokerage accounts allow for direct investments in the stock of individual companies, Treasury securities, agency securities, and corporate bonds.  Individual investors at Fidelity and Vanguard with an IRA account can purchase the same assets as investors with a brokerage account at the firm.

Individuals saving in plans that are not tax preferred can purchase bonds either through a brokerage account or through Treasury Direct.  Series I savings bonds can only be purchased directly from the Treasury and are therefore not available for retirement savers or for people utilizing 529 plans for college savings.

Retirement savers with an IRA can purchase Treasury Inflation Protected Securities (TIPs) through their brokerage company.   Whether this option is available through a 401(k) plan depends on the investment options chosen by the plan’s provider.  Most 401(k) plans that I am aware of do not allow for direct purchases of TIPs. 

Many financial advisors, including one mentioned in this CNBC article, favor the use of bond ETFs over direct purchases of Treasury securities.  The prices of the bond funds touted in this article appear highly variable. 

The use of bond funds instead of direct investments in bonds often results in inferior financial results.  Both bond prices and bond ETF or mutual fund prices vary inversely with interest rates.  The difference in financial exposure stemming from holding a bond and the financial exposure from holding a bond fund is that the bond holder can avoid losses by holding the bond until the maturity while returns for the holder of the bond funds are always dependent on interest rates.

All 401(K) plans have bond fund options. Many 401(k) plans have an option for short-term bonds that primarily invest in inflation protection securities.  However, even short-maturity bond funds designed to protect investors from the eroding effect of inflation can result in substantial financial losses for investors.

The returns for VIPSX are -10.45 % over a one-year holding period and 1.02 percent over a 10-year holding period.  Other short-term bond funds seeking to protect investors from inflation including STPZ and VTIP do not appear to be meeting their objective in the current macroeconomic environment.

There is one sure fire way to insulate your portfolio from inflation, the purchase of Series I bonds.  However, the IRS imposes an annual limit on the purchase of Series I bonds, and Series I bonds cannot be purchased in IRAs, 401(k) plans or 529 plans. Most household with most of their financial portfolio inside a retirement plan cannot purchase enough Series I Savings bonds to insulate themselves from inflation.

The performance of both long-term Treasury bonds and bond funds has also been miserable.  See BND, AGG, and FNBGX and look at the chart with the longest time span of historical prices.

Advantages of Direct Investments in Treasury Securities:

Investors who purchase a Treasury security at a positive yield and hold the Treasury security to maturity will never experience a nominal loss on the security.  

However, many investors will sell a long-term security prior to its maturity.

Investors should not purchase either a long-term bond or a long-term bond fund when interest rates are extremely low, as they were during the pandemic, since at that time interest rates were certain to rise and bond prices certain to fall.

Investors can spread out bond purchases over several months to assure monthly access to liquid retirement assets.  The purchase of six-month Treasury bills on six consecutive months would allow for monthly access to liquid assets.

The price risk of a Treasury security goes towards zero when the security nears its maturity date.  An investor needing funds shortly before the maturity date could sell the asset without a substantial loss, even if interest rates rise. By contrast, short-term bond funds have no maturity date, hence the price of the fund will fall if interest rates rise.

Investors can match the maturity of bonds that they hold with future liabilities.   This is an especially important feature for parents saving for college tuition who could match bond maturities with tuition payment due dates. 

However, 529 plans commonly used for saving for college generally do not have an option allowing for direct investments in Treasury securities.  Instead, the plans allocate investments into bond and stock ETFs or mutual funds.   The price of funds inside college 529 plans, even the short-term bond funds, vary substantially with market conditions.

Both savers in 529 plans and savers in retirement plans often save through a life-cycle fund that shifts assets from stocks to bonds as investors near retirement.  However, the component of the Lifecycle fund invested in a bond portfolio will fall in value when interest rates rise. 

Both bond and stock funds fell in tandem during the past year.  Lifecycle investing did not protect investors during the latest market downturn. 

Most retirees put all funds in instruments without a maturity date and base disbursements on a guideline like the four percent rule.  The four percent rule is not going to work if the value of both your stocks and bond funds simultaneously declines as they did most recently.

Retirees could and should purchase Treasury bonds and schedule the maturity of the bond for different dates each year.  The retiree would even consumption and reduce depletion of retirement assets by consuming from maturing bonds when the stock market is low and consuming from stock ETF distributions when the stock market is high.

Retirees with assets in bonds that mature on specific dates are better prepared for retirement than retirees with assets that have all savings tied up in funds without maturity dates.

Concluding Remarks:  The tax code provides preferences for investments in tax-preferred retirement accounts and 529 plans.  Congress recently passed legislation mandating automatic contributions to 401(k) plans. Financial advisors strongly recommend use of these tax-preferred savings vehicles.

Tax preferred savings vehicle often have limited investment options.

Tax-preferred savings plans often do not allow for the direct purchase of Treasury or government agency fixed-income securities with specific maturity dates, which could be matched with spending obligations.  

Moreover, financial advisors often advocate the use of bond funds instead of bonds with specific maturity date. 

Congress, through the tax code and their mandates and financial advisors through their insights guide investors to suboptimal higher-risk financial choices.

David Bernstein an economist living in Denver Colorado has written extensively on health and financial policy including a recent article outlining a 2024 Health Care Reform Proposal and an evaluation of President Biden’s student debt discharge proposal.

Evaluating the Biden Administration Student Debt Discharge Proposal

The Biden Administration student debt discharge proposal is being challenged in the courts and may be overturned. This one-time debt relief proposal does not change the trajectory towards higher student debt burdens. A credible case can be made for student debt relief to prevent a shock to consumption when student loan payments are reinstated. However, the proposal is arbitrary in who it assists and is not the most economically efficient or fairest way to address the pending economic shock from the reinstatement of student loan obligations.

The Biden Administration student debt discharge proposal is being challenged in the courts and may be overturned.  This one-time debt relief proposal does not change the trajectory towards higher student debt burdens.  A credible case can be made for student debt relief to prevent a shock to consumption when student loan payments are reinstated.  However, the proposal is arbitrary in who it assists and is not the most economically efficient or fairest way to address the pending economic shock from the reinstatement of student loan obligations.

The student discharge proposal:

The Biden Administration is proposing a one-time discharge of federal student debt.  Borrowers with a Pell grant can have up to $20,000 discharged.  Borrowers with a federal loan that were not eligible for a Pell grant could receive a loan discharge of up to $10,000. The amount discharged cannot exceed the amount of the loan.

Taxpayers with income less than $125,000 (single filers) or $250,000 (married filers) are eligible for the one-time debt discharge.

Student loans taken out after June 20, 2022, are not eligible for the loan discharge program.

Six states have brought litigation to stop the Biden Administration student discharge program on grounds that the Biden Administration exceeded their legal authority and that the law damages institutions in their state.  The Biden Administration claims their authority to provide student loan debt relief due to COVID stems from the 2003 Heroes Act which allows for relief under a national emergency and that the plaintiffs do not have standing to litigate this issue. The Supreme court has agreed to rule on this matter and the debt discharge proposal has been stayed pending the decision.

Some issues with the Debt Discharge Proposal:

Opponents of proposals to discharge student debt argue the programs are regressive because people with access to education due to their student loans will earn more over their lifetime than workers who never go to school.  This view was espoused by the moderate candidates in the 2020 Democratic primary including Joe Biden.

The student loan debt relief package is a one-time benefit.  It only favors people with debt incurred prior to June 2022.  It does not benefit future student borrowers.  It does not change the trajectory toward higher debt burdens for future cohorts of student borrowers.  

The absence of debt relief for people taking out student loans after June 2022 is necessary because the legal justification of the program is the COVID emergency.  It would be difficult to maintain that people taking out loans after June 2022 needed financial assistance because of COVID, at a time when all other COVID relief packages were ending.  

The Biden Administration attempts to ameliorate concerns that student debt relief favors high income professionals over workers by imposing income limits on eligibility for the debt discharge and by having a larger level of debt discharge for people who initially had income low enough to qualify for a Pell grant.  These arbitrary provisions don’t lead to the program automatically targeting the student borrowers who are most in need of assistance.

Income is highly variable, especially at the beginning of a person’s career.  The need for the loan discharge depends on salaries over many years not salary in one arbitrary year.

A person starting her career in the year of the discharge at a modest starting salary would automatically receive the discharge.  A person three years advanced on the same career path might not receive any financial assistance if her salary has risen.  For example, the debt discharge will be available for a doctor who is a resident during the year of the debt discharge program but will be unavailable for an attending physician.

A person leaving a high-powered job a year (a law associate who does not become partner) after the financial discharge provision would not receive any financial assistance despite the decrease in salary.

Many medical students who take on hundreds of thousands of dollars of debt may be more deserving of a debt discharge than students with less debt and lower debt burdens.  

The person who received a Pell grant may be better off than middle-class people who are ineligible for the Pell grant when the loan was granted.

The Biden Administration claims that the Heroes Act of 2003 gives the Administration the right to modify student loans in the case of a national emergency.  The plaintiffs in this case are arguing that relief offered the proposal is broader than what is allowed under the law and that the COVID emergency was only a pre-text for the program.  

The Biden Administration argues that without debt relief there will be a historically large increase in delinquencies and defaults.  A less expensive way to reduce defaults might involve freezing interest payments and reducing monthly minimum payments for a year or two after reinstatement of loan payments. However, the Heroes Act does not state that financial relief must be offered in the most efficient way.

No one knows how the Court will rule.  The Court is not well equipped to deal with the economic aspects of this issue. Congress has other levers, including the budgetary process and the debt limit, to force changes to the program.  

The one-time debt relief proposal is at best a band aid.  It does not address the continuing acceleration in college costs and student debt.  The debt discharge proposal is only one component of the Biden Administrations efforts to assist student borrowers.  Other programs including revisions to Income Driven Replacement (IDR) and some waivers for the discharge of current IDR loans will be addressed in a future post.

David Bernstein is the author of A 2024 Health Care Reform Agenda and Alternatives to the Biden Student Debt Plan.