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Possible Winners and Losers in a Student Loan Proposal

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Who would be helped by a 5 percent income cap suggested by the Biden campaign? High earners could wind up reaping the biggest benefits.

The student loan system is increasingly lenient to those who know how to navigate it, while still leaving many borrowers in danger of default.The student loan system is increasingly lenient to those who know how to navigate it, while still leaving many borrowers in danger of default.Credit…Andrew Kelly/Reuters

By Matthew Chingos

July 16, 2021

The Biden administration is still debating when to end the pandemic pause on collecting payments on federal student loans, but it’s also looking ahead at broader changes to how Americans repay those loans.

President Biden’s campaign proposal was to cap loan payments at 5 percent of incomes instead of 10 percent, and he may try to do so by creating a new income-based payment plan through the regulatory process. (He has not expressed interest in canceling all or most student debt.)

Unlike traditional payment plans in which payments are the same every month (usually for 10 years), income-based plans have borrowers pay a set percentage of their income over a specified threshold.

The Biden proposal would have significant benefits for many people, but there could also be unintended consequences, including an increase in inequality.

Because of how the loan system is set up, a 5 percent cap would be unlikely to help those who need it most (borrowers with low incomes are already eligible for zero payments); would cause some borrowers to pay for a longer period of time; and would provide large new subsidies to relatively affluent borrowers.

Income-driven repayment arrangements have grown from a pilot program introduced in the 1990s to plans that roughly 1 in 3 borrowers now participate in. Over time, these plans have become more generous.

The Obama administration reduced the share of discretionary income borrowers pay to 10 percent from 15 percent, and it reduced the number of years payments are required (before any remaining balance is forgiven) to 20 years from 25 years for borrowers with only undergraduate loans.

Tying loan payments to incomes has worked well in countries like Australia, in the judgment of experts, but not as well in the United States. For starters, borrowers have to know these options exist — less than half of undergraduates with loans did in 2016. Then they have to navigate multiple plan choices. If they fail to file annual paperwork with their loan servicer, they will be put back on a fixed-payment plan that may be unaffordable.

As a result, the loan system is increasingly generous for those who can navigate it, while still leaving millions in default. Black borrowers have borne the brunt of the defaults, at least in part because of racial wealth gaps and labor market discrimination.

Borrowers with low incomes (below $19,320 for a single person and $39,750 for a family of four in 2021) make no payments under existing income-based plans, so reducing the percentage of income paid will not help them.

Borrowers with modest incomes will pay less on their loans, although some will pay for longer. For example, Sandy Baum of the Urban Institute estimates that a borrower with $30,000 in debt and a starting income of $38,000 would pay for 20 years under a 5 percent plan instead of 15 years under the current 10 percent plan.

The size of the benefit would often be larger for people with larger debts. The hypothetical $30,000 borrower would be projected to save about $9,000, compared with $24,000 for someone with the same income who borrowed $50,000.

The borrowers with the highest incomes and largest debts — like doctors, lawyers and others with advanced degrees — would benefit the most. Under current policy, typical single borrowers with $150,000 in debt and a starting salary of $100,000 would eventually repay their full loan. Offering them a 5 percent plan would cut their monthly payments in half and provide a significant amount of forgiveness of remaining balances.

The Congressional Budget Office estimates that a more modest reduction in the share of income paid (to 8 percent from 10 percent) would cost more than $26 billion over the next 10 years, and most of the benefits would go to graduate student borrowers. A rough extrapolation would put the cost to taxpayers of a 5 percent plan at around $65 billion.

What are alternatives to a 5 percent repayment plan? One is to vary the share of income paid based on the borrower’s income. For example, borrowers might pay 5 percent of the first $10,000 of their discretionary income, and 10 percent on the amount above that. Or there could be an even more differentiated set of rates, akin to the U.S. tax system. This change would make payments more affordable for lower- and middle-income borrowers while avoiding billions in new subsidies for the relatively affluent.

Addressing the challenges most struggling borrowers face would require broader changes than tinkering with the share of income paid in a repayment plan that many borrowers don’t even know about. In some countries, borrowers repay directly through the tax withholding system, reducing the need for paperwork and loan servicing. But proposals to move to such a system in the United States have yet to gain traction.

For current borrowers, the Education Department has its work cut out improving the servicing of student loans in advance of payments resuming later this year or early next year. Though President Biden has expressed reservations about broad-based loan forgiveness, his administration has taken action to forgive the debt of students defrauded by their colleges.

One option for the Biden administration is to go further and forgive loans incurred at colleges where most students go on to earn poverty-level wages. (The government compiles data on the incomes and repayment rates of each college’s former students.) Targeted forgiveness strategies could be broadened to include all borrowers with persistently low incomes, including parents who borrow for their children, or who grew up in low-income families.

This would help those at greatest risk of default and do so at a lower cost (in part because higher default rates among lower-income borrowers mean that many of these loans would not have been repaid anyway).

The challenges of the loan system are rooted both in how loans are repaid and in how they are made in the first place. A consideration for policymakers is whether current policies such as unlimited lending to graduate students are doing more harm than good, and how to discourage low-quality programs more broadly. They might also think about whether borrowers who take on a smaller debt should repay their loans in a shorter time, rather than waiting up to 25 years for forgiveness. Many of these changes would require congressional action.

Cutting borrowers’ payments in half, as the Biden campaign proposed, would certainly benefit many people, and could encourage greater participation in income-based plans.

But the 5 percent income-based plan — in contrast to targeted forgiveness for those with low incomes — would do little to help those with the lowest incomes, while also providing a windfall to those with the highest incomes.

Matthew Chingos is director of the Urban Institute’s Center on Education Data and Policy. Follow him on Twitter at @chingos.

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