Think About Student Loan Reforms Rather Than Forgiveness

By Robert Gilway

September 28, 2022

Spending $400 billion to solve a particular problem is one thing. Spending all that dough and not solving that problem is another. But spending $400 billion and actually making the problem worse—hoo boy, maybe only Washington could pull off that terrible trick.

This isn’t just some hypothetical. According to a new analysis from the Congressional Budget Office, President Biden’s plan to cancel student debt for some borrowers could cost the federal government an additional $400 billion. (It’s worth noting that this fiscal estimate is an “uncertain” one, CBO director Phillip Swagel said in a letter to lawmakers, with the “the most uncertain components [being] projections of how much borrowers would repay if the executive action canceling debt had not been undertaken and how much they will repay under that executive action.”

But let’s say the $400 billion number is more or less correct. Would any problem be fixed? AEI scholar Beth Akers:

Student loan cancellation is being sold as an intervention to bail out struggling borrowers who were made victims by our unscrupulous system of federal student lending. But it’s hard, nay impossible, to reconcile that narrative with the actual implications of the policy. If Biden were in it to help struggling borrowers, he’d be working with Congress to enact systemic reform that would make things better for future students: shoring up existing safety nets, streamlining repayment to minimize the hassle for borrowers, and avoiding driving up future borrowing and prices. Instead, he’s taking a step that’s blatantly political. By canceling student debt through a one-time event rather than through thoughtful reform of the existing safety net, Biden will be driving students to borrow more and institutions to raise prices even faster than before.

What might “thoughtful reform” look like? One interesting idea comes from Richmond Fed economist Grey Gordon. (I urge you to check out his recent analysis that looked at to what extent student loans drive up college tuition.) In a recent podcast, he outlined a possible policy fix that would put the burden of student loan defaults onto their colleges, rather than the federal government:

Under the current system when a student defaults on their loan, the government effectively pays the tab. The government guarantees federal student loans under the current system. Under this proposed policy, it would be the individual schools who would be responsible for guaranteeing the loan. If you had a school that was essentially charging outrageous tuition and just trying to milk students, trying to get as much money out of them as they could without increasing their earnings capacity, then that type of school would probably have high default rates. If they had to bear the cost of those higher default rates, they would have two options. One would be to run out of money. The other would be to lower the tuition such that the tuition matches the extra earnings capacity of the students, so the students can pay back and not default on their loans. One of the nice things about this policy is it doesn’t really tie the hands of colleges. If delivering a quality education is very expensive, it would allow a college — say Harvard — to charge extremely high tuition, have huge student loans, and then have the students make a ton of money and pay those back. And the default rates can be low. It’s sort of screening what colleges are being productive and helping their students, and what colleges are really fleecing their students and not being productive.

Versions of this notion of giving colleges some “skin in the game” is something AEI scholars have also looked at: