Biden’s student debt plan flawed but the right move

Justified criticisms do not detract from positive impact

President Joe Biden’s administration was right to cancel $10,000 of student debt for millions of Americans.

In 2022 there is little question that the US student debt crisis is a pariah that speaks to both demonstrable policy failings and the considerable importance of post-1970s economic transformations. This amalgam of elements, which includes the rampant extension of credit since the 1970s, the growth of inequality and rising returns on ‘high-skill’ labour, has coalesced to exacerbate tuition costs and student indebtedness. It explains in large part why the US student debt total sits at $1.6tn, making it the largest source of private debt after mortgages.

And yet, unlike houses or cars, a university degree is not itself a source of wealth. Rather it is an investment that in most scenarios pays for itself many times over by increasing one’s lifetime income. But a greater number of Americans than ever before are paying far too much for degrees that offer them far too little. So, despite the numerous effective criticisms of Biden’s student debt order, the proposal to cancel $10,000 of debt for millions of Americans earning less than $125,000 ($250,000 for a household) makes sense both on economic and moral grounds.

First, it’s worth noting the central role the university degree has played in American history and US socio-economic cultural mythology. At the centre of the US’s enduring promise of opportunity is the concept of higher education as a vehicle to enter the middle class. And the growing share of Americans with both high school and university degrees helped fill some of the middle-wage labour market positions that emerged during this time.

The numerous public romanticists for this period of US history should be horrified by the increasingly poor return-to-investment that many US university degrees offer. As a continuation of their seminal paper ‘The Race Between Education and Technology’, economists Claudia Goldin and Lawrence Katz found that growing returns to ‘high skills’ are increasingly only produced by a more rarefied group of degrees and academic institutions. The implication is that the relative returns of higher education institutions outside of that pool are not offering the returns on wages that they were at the start of the century.

And yet, it is not just that returns have declined; it is also that the costs of university have gone up exorbitantly. Since 1980, the cost of a degree has nearly tripled in real terms – outpacing income. Some universities now charge roughly $80,000 a year for fees. At present, the average undergraduate completes university with $25,000 in debt. And this debt is usually taken on from the ages of 18 to 22, when a student may have little experience or few resources to evaluate the risks of such a debt burden, or even an understanding of how best to use a degree. A key reason for these increases in tuition is the decline of federal and state funding for many institutions. Yet a more important factor is the impact of credit extension in the US since the 1970s.

As easy access to credit became more readily available in the US, Americans’ capacity to finance more expensive tuition fees increased. At the same time, research by Goldin and Katz showed that a university degree was becoming more essential than ever before. And as competition grew increasingly fierce for access to top higher education institutions, the credit-induced increase in student tuition capacity encouraged universities to expand their fees in order to pay higher salaries, grow endowments and fund a wider range of programmes. Since the demand for degrees inevitably remained high given their growing labour market importance, students continued to apply to universities despite rising costs, and this necessitated a further extension of credit, allowing tuition costs to grow more and thus continuing the cycle.

Given these dynamics, it might be fair to conclude that the credit-enabled growth in higher education costs represents a distinct transfer of wealth in the US from younger students’ expected wealth towards older financiers and investors, who invest in collateralised student loan securities at least in part because they are guaranteed by the government. And such credit growth represents a transfer of the responsibility for funding higher education institutions to students. Pell Grants, offering student loan aid to low-income households, used to cover 80% of the cost of a 4-year degree. Now it only covers one-third of it.

And so, the student debt crisis originates in a mixture of policy failure and the expansion of US private credit. These elements partly justify Biden’s decision to forgive $10,000 in student loan debt ($20,000 for students who received Pell Grants).

Of course, there are unmistakable criticisms of the student loan plan that are worth taking seriously. In addition to costs as high as $1tn, there are legitimate questions about whether the bill is adequately targeting the right people, or if it goes far enough. And policy-makers and economists are understandably hesitant to support a bill that may transfer the student debt burden from elite graduates to taxpayers, who may not have benefitted from a higher education degree or who have already paid off their debt.

However, the student debt burden is weakening economic mobility and widening wealth inequality between generations (particularly for Black students). Meanwhile, a shrinking number of university degrees and institutions are providing a sufficient return to justify their cost. And students are not generally able to discharge their student debt in the form of bankruptcy, though Senator Elizabeth Warren is trying to change that.

The consequence is that for people whose higher education experience did not offer a return to justify its costs or even secure jobs – often through no fault of the individual – the risk of a long-standing debt trap and lifetime reduction in wealth is significant. And so, for many Americans, university has represented the exact opposite of the livelihood-boosting promise made at the height of the US’s post-war compression.

A better student debt plan – and one favoured by many economists – would tie student loan repayment contributions and debt cancellation to income. If a student earns a high-wage salary as a software engineer after graduating, they should be expected to contribute more to their student debt repayment than someone whose debt did not allow them to obtain higher-wage/higher-skill work. This is the underlying principle some private institutions offer in, for instance, law school repayment, where debt repayments are made as a percentage of income with guaranteed repayment after 10 years.

Under the current plan, it seems clear that some students expecting to see a lifetime of high earnings will also be recipients of the debt relief. And individuals who struggled to eventually pay off their debt are understandably miffed that they did not benefit from debt forgiveness. Lawsuits from Republican states and lawmakers are underway, possibly slowing down the debt relief. Moreover, the plan clearly makes only a small dent in the massive sum of accumulated student debt, while doing little to protect future students from high burdens. Meanwhile, the politicisation of the plan risks eroding public goodwill for future student debt relief initiatives.

And yet, Biden has taken a meaningful step to alleviate the US’s massive student debt burden. The initiative could have been more adequately targeted and gone further to protect current and future graduates. But the plan remains an unmistakably good thing for over 40m Americans and their families.

Julian Jacobs is Economist, OMFIF.

Image source: White House

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