Wiping out 10k in student debt is not the most expensive part of the Biden student loan program. Most Federal student loans are now eligible for an income based repayment plan, under these plans students pay a small percentage of their “discretionary” income, say 10%, and then after a fixed number of years the debt is wiped off the student’s books. At first glance these plans don’t seem crazy, but as Matt Bruenig points out they create perverse incentives.
Under the Public Service Loan Forgiveness (PSLF) program, law graduates that go on to work in the public sector, which is a lot of them as the public sector employs many lawyers, only have to pay 10 percent of their discretionary income for 10 years in order to have their debt forgiven.
Law schools figured out many years ago that, for a student who is planning to enroll in PSLF upon graduation, prices and debt loads don’t matter. Ten percent of your discretionary income is ten percent of your discretionary income regardless of what the law school charges you and how much debt you nominally have to take on.
Law schools also realized that they could make the deal even sweeter by setting up LRAPs [repayment programs, AT] that give graduates money to cover the the modest repayments required by the PSLF.
The LRAP schemes work as follows:
- The school increases their tuition.
- The student takes out federal loans to cover the tuition increase.
- The school squirrels away the debt-financed tuition increase into an LRAP fund.
- The school disburses money from the LRAP fund to cover PSLF repayments.
Did you get that? Here’s a stylized example. Suppose a student will make 150k per year for 10 years working in the public sector. If they have 200k in debt they pay 15k every year to the government for 10 years and then 50k is “forgiven.” But now the law school comes to the student and says ‘heh, I have a deal which will make both of us better off. We are going to raise the price of law school to 400k but don’t worry not only won’t that cost you a penny more than the 15k a year you are already obligated to pay it will actually cost you much less because we will pay your payments of 15k per year!’ This indeed is a great deal for the student who pays nothing and it’s a great deal for the law school which gets 200k more revenue immediately in return for 150k of payments paid out over the following 10 years. Win-win! Except for the taxpayer of course.
But wait there’s more. Student loans can be used not only to pay tuition and fees but also to pay “living expenses.” Thus, under these plans, students have an incentive to take out as big a loan as allowed in excess of tuition and fees because no matter how large the loan the student’s costs are zero! Lyman Stone has a good tweet thread giving many examples of how to game the system such as “Every student should borrow their maximum loan eligibility and then find some way to invest it illegally. My strategy would be: rent a wildly oversized apartment and sublet.” And here is a tweet thread from Michael Feinberg showing how even wealthy parents may be able to game the system.
Furthermore, the new Biden plan makes the income driven repayment schemes even more generous!
The IDR changes are four-fold:
- Increase the amount of income not subject to IDR from 150 percent of the federal poverty line to 225 percent of the federal poverty line.
- Reduce the interest rate on IDR-enrolled loans to 0 percent.
- For undergraduate debt, reduce the IDR rate from 10 percent of income beyond the threshold in (1) to 5 percent of income beyond the threshold in (1).
- For IDR-enrolled debts with original loan balances below $12,000, reduce the repayment period from 20 years to 10 years.
Essentially what this means is that every school will now have the possibility of using a law school like program to shift costs onto taxpayers. Thus Bruenig concludes:
…going forward, these new rules could quite radically alter the incentives of colleges and students when it comes to college prices, institutional financial aid, how much debt to take on, and how to approach repayment.
Indeed, these programs are likely to be very expensive and the resulting increase in the price of tuition will lead to calls either to end the program or for price controls on education.