Students Loan Cancellation: Winners and Losers

President Biden recently announced that he will cancel federal student loan debt owed by millions of Americans via executive order. Biden said this program will “help America win the economic competition of the 21st century.”

Despite all the goodwill from politicians there are many issues with the Biden plan. The simple program of student loan cancellation, which is basically a transfer program, gives money to small groups of borrowers at all the cost of taxpayers. Contrary to what its advocates claim, the majority of benefits will be given to borrowers with middle and high incomes. Students may be encouraged to borrow more than their income allows, knowing that they may not need the loan to repay.

According to the initial details, the plan would cancel up to $10,000 for student borrowers and $20,000 for low-income borrowers who received Pell Grants. The program would be limited to individuals with incomes less than $125,000 ($250,000 for couples), which is over 3.5 times the national median income. Estimates from the Penn Wharton Budget Model put the total cost of the program at around $300 billion.

Some parents will be able to cancel loans if they borrowed under the Parent Plus program. This would reduce the cost of borrowers choosing income-based repayment options and increase the Public Service Loan Forgiveness program. All federal student loans payments that were not subject to the post-Covid freeze will be exempted from this new payment.

Critics pointed out numerous disadvantages of student loan cancellations, particularly when they are done by executive orders.

Canceling student federal debt doesn’t eliminate it. The cost of the debt is passed on to the taxpayers. This is a wasteful and inefficient way of subsidizing low-income borrowers. To pay them directly, they would need congressional approval. This is why Biden chose to take this executive order action.

The precedent of executive order cancellation also creates negative incentives for future borrower, who may now expect that their debts would eventually be forgiven. These borrowers may choose to borrow more or pursue less-productive majors in response. As they may not be able to repay their student loans as quickly, even if they do have the ability, it will make them less likely to borrow more.

Supporters of loan cancellation claim the plan will benefit low-income borrowers and “help narrow the racial wealth gap.” However, research by the Federal Reserve Bank of New York found that disproportionately small amounts would go to minority or low-income borrowers. Their study shows that about 65 percent or more of the benefits of loan cancellation would go to middle- or high-income borrowers (although the analysis did not include the higher limits for Pell Grant recipients). While 54 percent of student debt is held by white borrowers, the New York Fed found that white borrowers would receive more than 60 percent of the benefits from loan cancellation.

It’s not clear if the president is legally authorized to cancel federal loans through executive order. Biden himself had previously said, “I don’t think I have the authority to do it.” Canceling debts is functionally equivalent to writing checks to the borrowers. Congress must approve federal spending. This approval will be the foundation for any legal problems.

Finally, student debt cancellation is unlikely to bring any economic benefits. Some believe that eliminating student debt will increase economic activity, as it allows borrowers to spend more. The federal government will need to increase its debt in order to make up for lost income from loan repayments. This will reduce private investment spending. It is possible that the net impact on spending could be negative. The effect on output, even if it has a large and positive effect on spending, will be minimal. Jason Furman, who served as chair of the Council of Economic Advisors under President Obama, believes it will mostly serve to drive up prices.

Politicians of the left argue that student loans can be bad for students from lower-income families and minorities, and that cancellation of loan is the only way to get rid. Sen. Richard Durbin, for example, said that “federal student loan debt weighs down American families and disproportionately burdens Black and Latinx households.” Sen. Elizabeth Warren added that “even before the pandemic the student loan debt crisis was already crushing millions of Americans.”

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Do these politicians truly believe that student loans are “weighing down” borrowers, and “crushing million of Americans?” Then why does the federal government continue to support student loans? Is it really necessary to continue to subsidise student loans that promote massive debt for low- and minority-income borrowers?

It’s very unlikely that politicians believe students are evil by lending money to them. This program is likely to be beneficial for voters of the left. Even at American taxpayers’ expense, they want to give benefits to constituents.

Student loan cancelation is a political ploy that favors the left, but harms most Americans. It discourages future students from being responsible with their money management.