The Stealth Student Loan Bailout

Authored by Jonathan Pidluzny via Real Clear Education,

The Supreme Court is likely to strike down the Biden Administration’s borrower bailout in the coming weeks.

The administration’s plan to transfer up to $20,000 in student loan debt per borrower - from individuals who voluntarily took out loans to finance their college education to unsuspecting taxpayers - is one of the most audacious examples of executive overreach in American history.

Despite its $400 billion price tag, the action is only a small piece of the administration’s strategy to create a massive new public subsidy for higher education. A cynic might wonder whether the headline-grabbing but legally dubious bailout now before the Court was conceived as a decoy to distract public attention from the real centerpiece of the debt-transfer agenda.

With public attention focused on the blanket forgiveness plan (and the pleas of those demanding more), the Department of Education was busy crafting an ambitious plan to bail out future borrowers in perpetuity by changing the rules governing income-driven repayment.

Currently, multiple income-based repayment programs exist. All would cap the payments of enrollees at a percentage of their current income and then wipe away debt that remains after many years of repayment. When income-based repayment plans are designed properly, they align the timing of repayment with career earnings trajectory, such that borrowers pay the loans back faster as their incomes increase. (It is reasonable for doctors with very large loans to have smaller payments in their residency years when salaries are modest).

But the design principle should be that most loans are eventually paid off, including interest, except in cases of manifest hardship.

With its proposal to phase out several existing income-based repayment programs in favor of a much more generous version of a specific program called REPAYE (Revised Pay as You Earn), the Department of Education is abandoning this expectation to create an ongoing bailout.

REPAYE’s extravagant new terms are a bad deal for taxpayers. Undergraduate borrowers will be required to pay only 5% of their disposable income toward their student loan debt, with disposable income defined as income above 225% of the federal poverty line ($32,805 for an individual or $67,500 for a family of four). Balances will not grow when a borrower’s monthly payment is smaller than the interest accrued. (To accomplish this benefit, the Secretary of Education claims the power to cease charging interest owed to the U.S. Treasury.)

Outstanding balances will be forgiven under the program after 10 to 20 years depending on the size of the original balance. Forever.

The program will subsidize college attendance for borrowers across income levels. According to Department estimates, borrowers in the lowest 20% of lifetime earners will see the cost of college discounted by 90% relative to the status quo.

This means that on average, they will repay $873 for each $10,000 borrowed prior to the cancellation of the remaining principal. Borrowers in the second lifetime-income quintile will receive a 65% discount on the cost of college, and borrowers in the third and fourth income quintiles will receive 37% and 13% discounts, respectively. The Urban Institute estimates that under proposed changes to REPAYE, only 22% of those who complete a bachelor’s degree with typical levels of debt will repay their debt entirely (49% will repay less than half).

Concretely, a household of four earning $80,000 per year with $30,000 in student loan debt would be expected to pay approximately $291 per month under the current version of REPAYE. Under the new rule, that payment would drop to just $52 per month.

Of course, the debt does not disappear when the balance is ultimately canceled. It gets transferred onto the backs of taxpayers. In effect, the Department of Education is in the process of creating a new, permanent, social-welfare program that disproportionately benefits the highly educated—all without congressional authorization or appropriation.

If the program goes into effect, American taxpayers will be on the hook for a much larger proportion of higher education expenditures nationwide. The Congressional Budget Office (CBO) estimates that the action will cost $230 billion over the next decade, assuming the Supreme Court allows the first bailout to proceed. If it does not, much of the loan debt that would have been forgiven this year will be canceled in years to come under the Income-Driven Repayment (IDR) rule’s provisions.

The CBO estimate also does not fully account for the inflationary impact of the stealth bailout proposal. Research has shown that when the pool of financing available to students increases, colleges find it easier to raise tuition rates (they often “invest” in luxury facilities and armies of DEI administrators and pass the costs on to students and taxpayers). Families with the wherewithal to pay for college out of pocket will instead choose to borrow in order to access the potential subsidy. Who can blame them when government policy creates an incentive to leave their money in the stock market and use investment gains to pay down the loan at a discount in the decade following graduation?

Because the new program would artificially cap repayment below the cost of college for most borrowers, students will also have an incentive to overspend on college, comfortable in the knowledge that REPAYE’s cancellation provision effectively sets a repayment ceiling. Similarly, underprepared students will be recruited to enroll with the promise that their loans will be forgiven if they do not complete their degrees and secure remunerative employment. This destroys individual incentives to be budget-conscious and attentive to price when selecting an institution and area of study. In short, the regulation will drive up the cost of college in myriad ways and, with it, taxpayer-funded higher education spending.  

All of which is to say that when the Supreme Court issues its judgment in Biden v. Nebraska later this month, the debate about student loan forgiveness will not be over. The coming IDR reforms are even more radical than blanket forgiveness—and very likely to provoke additional legal challenges and congressional scrutiny in the years ahead.