“impact Of Student Loan Debt On Long-term Financial Planning And Retirement”

“impact Of Student Loan Debt On Long-term Financial Planning And Retirement” – Note: We published a follow-up article on June 3, 2021, estimating fiscal multipliers of $10,000 and $50,000 for federal student loan debt cancellation, which can be found here. We estimate the multiplier to be between .02x and .27x, with a central estimate of .13x for a $10,000 debt cancellation and .10x for a $50,000 cancellation.

With a weak economy still reeling from the effects of the COVID-19 pandemic, there have been a number of calls for President-elect Joe Biden to support the economic recovery by canceling some or all student loan debt.

“impact Of Student Loan Debt On Long-term Financial Planning And Retirement”

There is debate about whether the president has the legal authority to cancel the debt by executive order, and whether it would be good policy overall. However, one thing is clear: Student debt cancellation would be an ineffective form of stimulus that would provide little boost to the economy in the near term compared to the costs. Assuming the loans are tax-exempt, we estimate an economic multiplier of 0.08x to 0.23x.

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There are a number of benefits and costs associated with canceling student debt. But as a measure of stimulus, its “bang for the buck” is far lower than many of the alternatives being considered or the COVID relief already in place.

Economic stimulus works by increasing aggregate spending when the economy is in a period of weakness. Still, student loan debt forgiveness will have a relatively small impact on what you can afford to spend.

Total debt forgiveness would increase household wealth by about $1.5 trillion (it would cost the government the same), but that’s not the equivalent of sending $1.5 trillion in cash to households. Instead of giving the average family $15,000 or $20,000 more to spend, it would free up their monthly interest and principal payments, which are usually $200 to $300 a month for a typical borrower.

In other words, because borrowers often pay off their loans over 10, 15, or even 30 years, debt forgiveness will increase their available cash by just a fraction of the total loan forgiveness.

How Student Loan Forgiveness Could Impact U.s. Economy

Our analysis of the student aid portfolio suggests that eliminating $1.5 trillion in loans would mean $90 billion or less in cash available in 2021 and $450 billion or less over 5 years.

Only eliminating some debt—for example, by imposing a $10,000 or $50,000 limit—will reduce costs and cash flow effects roughly proportionally.

These figures may be overstated given the new cash flow tax law in effect. Generally, the loan forgiveness amount is treated as income and subject to tax. As Jason Furman, the former chairman of President Obama’s Council of Economic Advisers, noted, the payoff from this forgiveness could be greater than the savings in paying off the short-term loan. Under this tax treatment (which some argue may change or is a misunderstanding of existing law), loan forgiveness may be

On the other hand, the absence of future debt may lead some individuals and families to spend more from savings or by taking alternative loans, a phenomenon known as the wealth effect. Empirical evidence suggests that an increase in the value of one’s home or stock portfolio increases spending by 3 to 6 cents for every dollar of increase in wealth. This translates into an additional cost of approximately US$50 to 100 billion. This is a small economic impact compared to the $1.5 trillion cost.

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Not only would loan cancellation provide families with relatively little cash, but the cash it would offer would be poorly targeted in terms of incentives.

Stimulus dollars that are spent rather than saved provide a stronger boost to near-term economic output. In general, low-income individuals or those who have experienced a recent negative income shock are more likely to spend additional resources. Still, a large share of debt relief will go to those with higher incomes and those who have maintained their incomes during the current crisis.

The majority of those most affected by the current economic crisis likely have little or no student debt. Seventy percent of current unemployed workers do not have a bachelor’s degree, including 43 percent who did not attend college at all. Meanwhile, less than one-third of student debt is held by families without a bachelor’s degree, and less than one-tenth is held by those with no college education. Indeed, about two-fifths of student debt is borne by families with college degrees. This group makes up less than a tenth of the total unemployed.

A recent Pew survey similarly found that most of the economic suffering caused by the pandemic is concentrated among those with less education and therefore less (or no) student debt.

Understanding The Tax Implications Of Student Debt Forgiveness

Based on these data, it is unlikely that widespread student debt cancellation would be well-targeted to those who would experience a loss of income. Nor is it well-targeted for those with low incomes. The Brookings Institution recently estimated that nearly three-quarters of student loan payments in a given (pre-pandemic) month were made by people in the top two quintiles. Only a tenth of loan payments come from the bottom two quintiles, the highest spending groups.

The low number of repayments by low-income borrowers is largely due to the distribution of the loans themselves. But it’s also because students struggling with student debt can already take advantage of lower-paying income-based repayment programs or, in the face of short-term income shocks, pre-pandemic forbearance and deferment options.

Forgiveness dollars are poorly calculated for those who spend—based on income or loss of income—borrowers’ cash flow savings are unlikely to have a high multiplier. CBO recently estimated that the CARES Act recovery rebates—which provided $1,200 per adult and $500 per child to nearly all families earning less than $150,000 a year—were 0.6x. Loan cancellations are inherently less targeted than these rebates – which are already relatively untargeted – and therefore likely to have a much lower multiplier.

Targeting would be somewhat improved by capping loan forgiveness amounts at, say, $50,000 or $10,000 (as in President-elect Biden’s campaign plan); or income-based, but any form of loan cancellation only goes to those with some college education who borrowed in school. Therefore, even a better-targeted version is likely to be less incentivized than universal checks and much less incentivized than more targeted interventions such as expanded unemployment benefits.

Federal Student Loan Debt Relief And New Mexico Students And Grads

Loan forgiveness has a very small multiplier and similar incentives can be provided at a fraction of the cost

Assuming a 0.4x to 0.6x multiplier from additional cash flows from loan forgiveness, along with a 3 to 6 percent wealth effect, $1.5 trillion in debt relief could generate $115 to $360 billion in economic productivity during the current downturn.

These multipliers are much lower than almost any other policy currently being considered or enacted during the recent COVID relief. For example, CBO estimated that the recent expansion of unemployment benefits had a multiplier of 0.67x and the broad recovery rebates were 0.60x – both of which would be higher in future legislation due to less social distancing.

Debt cancellation is an especially poor incentive compared to the alternative of continuing the student debt relief policy. Beginning March 13, a combination of legislative and executive actions delayed almost all student loan payments and forgave interest accrued during that time. As a result, only 7 percent of student loan dollars are currently being paid off—leaving most families with extra cash to spend.

Is Taking On More Student Debt Bad For Students?

That delay is scheduled for Dec. 31, but could be extended through the remainder of the pandemic by executive action. Extending this policy would generate the economic stimulus that comes with debt cancellation, but only at a fraction of the cost.

1 This assumes that all paid-off federal student loans will be canceled, including those in the Federal Family Education Loan (FFEL) program. However, some of these loans held by private lenders may not be eligible for cancellation, and therefore some or all may not ultimately be canceled.

2 The flexibility of repaying federal student loans through income-based repayment options means that a $10,000 write-off will not result in a proportional increase in cash flow. Currently, anyone with student loans can enroll in a repayment plan that ties their monthly payment to their income. CBO estimated in February that nearly half of the dollars covered in the main “Direct Loan” program came through income-based plans. So even without current interest forgiveness and automatic forbearance, many people enrolled in income-driven repayment plans won’t see any change in their monthly payments. This would, of course, completely eliminate payments for those who owed less than $10,000, but for those who owed more, it would only shorten the time it took to repay the loan, not the amount. This will not stimulate the economy in the short term. Indeed, of all the types of loan programs that can be offered, the student loan program is the least incentivized, since repayment is the most flexible.

3 Evaluation of a stimulus should focus on its effect

Student Loan Relief: How Would Biden’s Plan Affect You?

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