The notion of student-loan cancellations has been capturing the attention of politicians and those in the realm of higher-education policy for well over a year now. Despite the popularity of this hugely regressive idea, it’s a terrible one. Thankfully, there’s a better, more moderate way to address federal student debt. And it’s hiding in plain sight.
Income-driven repayment (IDR), an existing set of programs that function somewhat poorly, can be improved to ensure that not a single borrower will ever have to make an unaffordable payment on federal student loans. Under IDR, monthly payments are tied to a borrower’s income and unaffordable balances are ultimately forgiven. IDR accomplishes this in a way that minimizes moral hazard and delivers benefits in a true progressive manner — with more benefits going to people who invested in a college degree, and took on debt to do so, but didn’t see the return they were promised in the form of a high-paying job. IDR also makes college more accessible to children in low-income families, in effect enabling higher education to function as a mechanism for social mobility.
The monthly payments of traditional loans are determined at the outset, with repayment of the principal and interest spread over a definite time period. In contrast, IDR allows borrowers to make monthly payments that are equal to a fixed percentage of their current disposable income. When income is high, they pay the full amount due, and when income is low, they can make a reduced payment without penalty. This ensures that monthly payments are affordable. The balance is forgiven once a borrower has made a requisite number of IDR payments. This takes between ten and 25 years depending on the student’s eligibility and choice of IDR program. Borrowers may not like having a balance hanging over their head for that long, but the reduced monthly payments (often reduced to zero) mean the process isn’t excessively burdensome.
By reserving benefits for those who are truly in need, the IDR mechanism also reduces the perversion of incentives that often come with implementing safety nets. A less targeted relief program, like the student-loan forgiveness being proposed, would likely encourage future students to borrow more than they would have otherwise, attend more expensive schools, and make less of an effort to constrain living expenses (also paid with loans). It would also fuel hope for another politically supported round of loan forgiveness down the road. Taxpayers, who ultimately pay the price for these programs, are thereby saddled with even more costs. Colleges and universities would in turn raise prices to respond to the surge in demand, which would exacerbate the already out-of-control inflation in the higher-education industry.
Some might wonder if a safety net for student borrowers is really necessary. But if we want more Americans to use our system of higher education, which includes both work-training and degree programs, we have to minimize the financial risk students face. While investment in higher education generally pays huge dividends, degrees don’t always lead to high earnings that would justify the cost. Students who start school but don’t finish are the worst off, as they end up with a significant loan balance to repay without access to earning levels that would make repayment affordable. Without a safety net, it is still not truly affordable for students from low-income families to attend college. Delivering relief through a safety net allows for a more efficient allocation of resources, because benefits needn’t be paid to those who invest in college and end up with a lucrative career.
Despite the IDR system’s appropriateness for the policy challenge at hand, the system hasn’t been working well. The reason for this is largely that IDR is administered through a variety of programs each with different eligibility criteria and a range of program parameters. The amount borrowers are expected to pay is calculated differently across programs, as is the number of years before borrowers can qualify to have their balance forgiven. The result is a system that is excessively complex to navigate, with many borrowers unaware of the benefits that are available to them. While IDR is now universal for all federal student borrowers, it became that way only after a series of legislative and executive interventions, between 1992 and 2015, stitched together a patchwork of loosely related programs. Factual evidence about how IDR has been used is limited, but anecdotes about the challenges of navigating the system, even by financially savvy consumers, indicate systemic problems. This rickety policy framework desperately needs to be replaced with a single user-friendly, income-driven repayment plan that can be universally marketed and better understood.
Reasonable people can disagree about how generous IDR should be. Moving the conversation away from mass loan forgiveness to reforming IDR would be a step in a fairer and more efficient direction.