Redesigning Education Finance: How Student Loans Outgrew the 'Debt' Paradigm
79 Pages Posted: 1 Apr 2020
Date Written: March 6, 2020
Federal student loans are fundamentally different from any other type of credit product: they do not require the full repayment of all principal and accrued interest. Instead, borrowers have the contractual right to satisfy their obligations by paying only a percentage of their income for a fixed period of time. In other words, debt forgiveness is contractually baked into the student loan product.
This and other unusual features of federal student loans reveal that the economic structure of student loans has evolved to resemble a federal grant program coupled with a progressive income-based tax on recipients, rather than a true debt product. The education finance system, however, still relies on the legal, financial, and institutional apparatus of “debt” that developed under the pre-2010 structure of the education finance system, which was based on private loans backed by federal government guarantees, rather than today’s direct federal lending program. These legal, financial, and institutional structures are a mismatch with the current program’s economic realities and policy goals.
This Article argues that nearly all of the problems in education finance, including high levels of default, abusive servicing, and even the very idea of a student debt crisis arise from the frictions between the legal and institutional apparatus of “debt” and the economic reality of subsidized finance and progressive, income-based repayment and debt forgiveness.
Accordingly, this Article argues for calling federal student loans what they really are—a tuition grant plus an income surtax on students. To this end, it proposes a set of targeted reforms: automatic income-based payments using a graduated rate schedule; collection through the tax withholding and return filing system; and replacement of interest accrual with an inflation adjustment. Moving to a grant-and-tax framework would facilitate substantial reforms to the financing of higher education and help ensure that federal financing fulfills its beneficial purpose of facilitating affordable higher education, rather than being a debt trap.
Keywords: student loans, higher education, tax, debt, income-driven repayment
JEL Classification: H20, H52, I22, K34
Suggested Citation: Suggested Citation