During this year’s Democratic presidential primaries, numerous candidates championed the idea of forgiving some or all of the student debt held by the federal government. Massachusetts senator Elizabeth Warren proposed canceling up to $50,000 in debt for nearly all borrowers; Vermont senator Bernie Sanders advocated wiping away all student debt. Now that president-elect Joe Biden, who has endorsed some measure of debt forgiveness, is set to take office on January 20, 2021, the notion of canceling student debt has only gained momentum.
But who benefits from such forgiveness would depend largely on how it’s structured. Some policy approaches could chiefly benefit the highest earners, suggests research by University of Pennsylvania’s Sylvain Catherine and Chicago Booth’s Constantine Yannelis.
In the United States, about 43 million borrowers collectively owe nearly $1.6 trillion in outstanding federal student debt, according to the Department of Education’s office of Federal Student Aid. That balance has more than tripled since 2007, while the number of borrowers has only increased by about 50 percent.
There are a number of ways policy makers could go about relieving some of this burden, and Catherine and Yannelis focus on three broad approaches to debt cancellation: universal forgiveness (canceling all student debt for everyone), capped forgiveness (canceling up to $10,000 or $50,000 of every borrower’s student debt), and targeted forgiveness (wherein borrowers’ relief is tied to their income). Using data from the Federal Reserve Board of Governors’ 2019 Survey of Consumer Finances, the researchers examine how student debt is distributed throughout the income spectrum, and how that would define the beneficiaries of various debt-relief plans.
They find that following universal student-debt forgiveness, the average person in the top decile of the earnings distribution would receive more than five times as much relief as the average person in the bottom decile, and almost half of all relief would go to people in the top 30 percent of the distribution. “Patterns are similar under policies forgiving debt up to $10,000 or $50,000,” they write, “with higher-income households seeing significantly more loan forgiveness.”
There are two primary reasons why the better off would benefit most, Catherine and Yannelis explain.
First, as prior analyses have shown, loan balances are correlated with income. Broadly speaking, before surgeons, lawyers and executives embark on their lucrative careers, they often amass large debts from advanced-degree programs. But just looking at balances understates the degree to which the benefits of student-debt forgiveness would pool at the top of the income distribution, the researchers say. Focusing on the balance of a loan ignores its present value—the total value today of all future payments on the loan, factoring in the rate of return that money would earn on a risk-free investment.
That gets to the second reason: The researchers find that because borrowers further down the income distribution are less likely to repay their loan in full, the ratio of a debt’s present value to its balance increases with income. For those in the bottom income decile, the present value of student debt is about 40 percent of the balance, whereas present value and debt balance are almost equivalent for those in the top decile.
“Once you factor that in,” Yannelis says, “universal student-loan forgiveness policies are actually much more regressive than if we simply look at balances, because the ratio of present values to balances is much lower at the bottom of the income distribution relative to the top.”
Catherine and Yannelis find that targeted forgiveness policies known as income-driven repayment programs are much more effective at concentrating debt relief toward the bottom and middle of the income distribution. IDRs, as the name suggests, tie monthly loan payments to borrowers’ income: under typical terms, an IDR participant might pay 10 percent of whatever income she has that falls above 150 percent of the poverty line. After a certain number of years—20 or 25, depending on the plan—her remaining balance is forgiven.
Enrolling all borrowers in an IDR program would result in the bottom earnings decile receiving four times as much forgiveness (in terms of dollars forgiven) as those in the top decile, the researchers calculate, with 69 percent of benefits going to borrowers in the third through seventh deciles. Increasing the threshold below which individuals don’t pay any of their income to 300 percent of the poverty line, up from 150 percent, would produce similar distributional results, but with more relief going to middle-income borrowers.
The analysis also suggests that IDR-based forgiveness would have a smaller fiscal impact than universal or capped forgiveness. Enrolling all borrowers in an IDR program with a 300 percent threshold would entail slightly less forgiveness—as measured by present values—than a $10,000-capped policy, and far less than a $50,000-capped plan. But following that same IDR policy, the bottom 60 percent of the income distribution would receive more forgiveness than with a $10,000-capped policy, and the bottom 30 percent would see more forgiveness than with a $50,000-capped policy.
Calls for debt relief are likely to continue. But Yannelis says that the policy discussion about student-debt forgiveness often misses the “simple point that we’re not really forgiving debt. We’re simply transferring debt from student borrowers to taxpayers, which makes it important to think about the distributional effects of this transfer.”