Student Loan Forgiveness in the United States: A Well-Intended Band-Aid

President Biden’s recently announced college loan forgiveness policy is a well-intentioned response to an appalling and ongoing crisis for the millions of American citizens who now owe $1.7 trillion in US student loans. Just for perspective, that’s slightly more than the current Australian annual GDP.

The recent major disruption in labor markets internationally due to the effects of COVID-19, including for new graduates, as well as the extraordinary increases in US debt per student, have demanded a policy response.

But are the reforms of the Biden administration sufficient to deal with the scale of the crisis?

The Biden reforms cancel up to $20,000 in loans for people earning $125,000 a year or less and an additional $10,000 for other borrowers from low-income backgrounds. The plan would erase the debts of around 50% of borrowers, all of whom currently earn relatively low incomes.

The advantages are quite clear: it prevents debtors who now have great difficulty repaying their debt from defaulting on their student loans. A formal default on a US student loan is a major calamity in someone’s life. This can hurt their credit scores, which can limit access to future loans, including home financing. Currently, there are at least nine million American student borrowers with the unenviable and harmful tag of “credit risk” that comes with default.

The Biden policy is also aimed at those who need the most help: low-income people. A holistic approach to debt cancellation would unfairly help many who have high debts, but also have lives of high earning power and career success. Think of doctors, lawyers and business leaders. These people in general really don’t need debt relief and it would be like taking on all taxpayers, including those on low incomes, to cancel the debt of high-paying people.

But while this policy helps those who need it most in times of crisis, ultimately the policy focus is misplaced. Biden’s forgiveness strategy is just a band-aid. It’s because the whole catch in the system – how debts are paid off – is ignored.

The fundamental flaw in the US student loan system, indeed the student loan systems of most countries in the world, is in the nature of debt repayments. The problem is that university credits are collected on the basis of time, the usual duration being 10 years of repayment, where the monthly dues are identical and unwavering.

This means that if a former student is unemployed, ill, or caring for an elderly parent or newborn, they owe the same amount per month. And bearing in mind that about 40% of student debtors are undergraduates, even many of those in full-time employment will struggle to repay their debts.

This means that even if Biden’s loan forgiveness policy is well-targeted and minimizes trauma for a cohort of debtors right now, what about next year and all the years after? Will it have to be done again and again, even permanently ad hoc base?

Thousands of bandages will be needed year after year, crisis after crisis, to cover an open wound. It’s only cosmetic, a temporary disguise of a permanent problem.

There is a solution available to anyone looking beyond the borders of the United States. For 33 years in Australia, 30 years in New Zealand, 25 years in the UK, “income contingent loans” have supported the higher education systems of these countries. To avoid a US-style loan crisis, students in these countries only need to repay when they have the financial capacity to do so.

What if a student is unemployed? Their reimbursements are suspended. If their income drops because they are raising a child or caring for a sick family member? Refunds are suspended. On top of that, there is no way they can damage their credit score.

There are some forms of income-contingent student loan repayment in the United States, but they do little to address the current problem. These types of loans have limited coverage, are very difficult to navigate, and loans are collected based on last year’s revenue, not current, which adds to the collection burden on the US government. (In the countries above, employers simply take the amount of the loan repayment from wages – a much more efficient approach.)

A longtime advocate of the United States’ adoption of a variation of the Australian/British loan system, Harvard economist Professor Susan Dynarski recently wrote: “Loan forgiveness is not just justified; That’s right: government policy has done harm, and it’s government policy that should help reverse it.

True, but until the United States turns to comprehensive remedies abroad, it will not treat the wound that has long healed in other countries.


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