Research suggests a smarter way to tackle student debt



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Editor’s Note: This article was written by Constantine Yannelis, assistant professor of finance at the Booth School of Business at the University of Chicago, and shared by Chicago booth review. The essay is based on Yannelis’ testimony submitted to the US Senate Committee on Banking, Housing, and Urban Affairs Economic Policy Subcommittee in April 2021.

Education is the single most profitable investment most Americans will make, so having a good system of financing higher education is fundamentally important for American households and the economy.


A key point in the student loan debate is that borrower outcomes vary widely. Undeniably, a significant number of borrowers are in difficulty and are sympathetic candidates for some form of relief. Student loan balances have increased over the past decades. According to the New York Fed, last year’s student loans had the highest default rate of any form of household debt.

Most student borrowers end up with higher incomes and have no difficulty repaying their loans. A college education is, in the vast majority of cases in America, a ticket to success and a well-paying job. Of those who have difficulty repaying their loans, a large proportion have attended a relatively small number of institutions, mainly for-profit colleges.

The heart of the problem in the student loan market is the misalignment of incentives for students, schools, and government. This lag stems from the fact that borrowers use government loans to pay school fees. If borrowers end up getting mediocre jobs and fail to repay their loans, schools don’t have to pay – taxpayers pay the costs. How to solve this incentive problem? There are many options, but one of the most common solutions offered is universal loan cancellation.

Various forms of blanket student loan cancellation have been suggested, but all of them are extremely regressive, helping high-income borrowers more than low-income borrowers. This is mainly because people who attend university tend to earn more than those who do not, and people who spend more on their university education, such as those who attend medical schools. and law, tend to earn more less on their college education, such as dropouts or associates’ degree holders.

My own research with Sylvain Catherine of the University of Pennsylvania shows that most of the benefits of a universal loan cancellation policy in the United States would go to high-income people, those in the top 20 percent. rich in the income distribution, who receive six to eight times more debt relief than individuals in the bottom 20 percent of the income distribution. These basic patterns hold true for capped rebate policies which also limit the rebate up to $ 10,000 or $ 50,000.

Another problem with the capped student loan forgiveness is that many troubled borrowers will still be in trouble. A small number of borrowers have large balances and low incomes. Policies that forgive $ 10,000 or $ 50,000 in debt will leave their important problems unresolved.


While phasing out income – policies that limit or remove relief for people above a certain income threshold – make forgiveness less regressive, they are blunt instruments and lead many people to earn money. large amounts over their lifetime, such as medical residents and clerks with substantial loan forgiveness.

One fact that often goes unnoticed in the policy debate is that we already have a phased student loan waiver program, and that is payback on income.

While policymakers want to ensure that funds flow gradually to borrowers at the bottom of the income scale, blanket student loan forgiveness does not meet this target. On the contrary, the policy mainly benefits high incomes.

While I am convinced from my own research that student loan forgiveness is regressive, this is also the consensus of economists. The Chicago Booth Initiative on Global Markets asked a panel of eminent economists to comment on this statement: “The government issuing additional debt to pay off outstanding loans would be net regressive.” The panel included economists from leading institutions on the left and the right. The results of the investigation were revealing. Not a single economist disagreed with the idea that student loan forgiveness is regressive. Indeed, the facts are clear – to borrow a commonly used expression, “The science is established” – the forgiveness of student loans is a regressive policy that primarily benefits the high income and upper middle class.

Another facet of this political question is the effect of student loan forgiveness on racial inequality. One of the most distressing failures of the federal loan program is the high default rate and heavy loan burden for black borrowers. And student debt has been implicated as a contributor to the wealth gap between blacks and whites. However, data shows that student debt is not the primary driver of the wealth gap, and student loan cancellation would make little progress in closing the gap, but at great cost. The average wealth of a white family is $ 171,000, while the average wealth of a black family is $ 17,150. The racial wealth gap is therefore approximately $ 153,850. According to our article, which uses data from the Survey of Consumer Finances, and regardless of the current value of the loan, the average white family has $ 6,157 in student debt, while the average black family has 10,630. $. These figures are unconditional on the holding of student debt.

So if all student loans were canceled, the racial wealth gap would drop from $ 153,850 to $ 149,377. The loan cancellation policy would cost around $ 1.7 trillion and narrow the racial wealth gap by only about 3%. Surely there are much more effective ways to invest $ 1.7 trillion if the goal of policymakers is to close the racial wealth gap. For example, targeted, means-tested social insurance programs are much more likely to benefit black Americans compared to forgiving student loans. For most American families, their greatest asset is their home, so increasing property values ​​and homeownership among black Americans would likely do a lot more to close the racial wealth gap. Yet the racial income gap is the main driver of the wealth gap; wealth is ultimately determined by the incomes and skills of workers, what economists call human capital. In summary, canceling student loan debt is an expensive way to close a very small portion of the wealth gap between blacks and whites.

How to relieve borrowers who need it, while avoiding making large payments to wealthy individuals? Lawmakers need to consider a number of policy options. One is to restore bankruptcy protection for student loan borrowers.

Another option is to expand the use of income-based reimbursement. One fact that often goes unnoticed in the policy debate is that we already have a graduated student loan forgiveness program, and that is Income Based Repayment (IDR). IDR plans tie payments to income: borrowers typically pay 10-15% of their income above 150% of the federal poverty line. Depending on the plan, after 20 or 25 years, the remaining balances are canceled. So, if the borrowers earn less than 150% of the poverty line, as low income individuals they never pay anything and the debt is forgiven. If borrowers earn small amounts above 150 percent of the poverty line, they make some payments and receive partial forgiveness. If the borrowers earn a high income, they pay off their loan in full. Simply put, high income people pay more and low income people pay less. IDR is therefore a progressive policy.


IDR plans provide relief to distressed borrowers who are facing adverse life events or who are otherwise unable to earn high income. There have been issues with the implementation of IDR plans in the United States, but these can be resolved, including through recent legislation. Many countries like UK and Australia run successful IDR programs which are administered by their respective tax authorities.

Beyond helping borrowers, which is important, we could do more to address technical issues and incentives. We could give repairers more tools to contact borrowers and educate them about repayment options such as IDR, and we could also encourage repairers to enroll more people in an IDR plan. But while we may be able to make some technical fixes, services are not the root of the problem in the student loan market: a small number of schools and programs are causing a large number. part of the negative results.

To address this issue, policymakers can also directly align incentives for schools and borrowers. For example, Brazil, which has experienced similar problems with its student loan program, recently gave schools the skin of the game by forcing them to pay fees based on dropout and default rates. This helped align the incentives of schools and student borrowers. Getting revenues to flow directly to schools from IDR plans, or implementing revenue sharing agreements in which individuals pay an uncapped portion of their income, could also help align incentives for schools, students and taxpayers.

Federal student loans are an important part of funding colleges and intergenerational mobility. The root of our student loan crisis is a misalignment of incentives. Since the problem has been so slow and continuous, I like the analogy of a frog slowly boiling in a pot of water over a flame. Policies like canceling student debt don’t extinguish the flame, they don’t solve the incentive problem. All they do is move the frog to a pot of slightly cooler water. And if we don’t get to the heart of the matter, even if we write off $ 50,000 in debt for current borrowers, balances will continue to grow and we will face a similar crisis in 10 or 20 years.

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