The author recieved his Ph.D. in economics from Purdue University. He worked as an economist in the U.S. Treasury from 1988 to 2012 when he retired. He lives in Lorton Virginia with his family. He write books, consults and a blog www.economicmemos.com.
Student Loan Forgivenessby David Bernstein
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The current generation of students is leaving school more highly leveraged than any previous one. While education remains a good investment for the average student borrower, some students will never be able to repay their student loans in full. This paper considers the possibility of changing policies and laws in order to make it easier for some highly leveraged students to have some of their student loans forgiven. Three programs or policies – (1) the Income Based Replacement (IBR) loan program (2) the discharge of student debt in bankruptcy, and (3) the treatment of student debt in chapter 13 – are assessed.
My assessment of these programs reached the following conclusions:
The take up rate for the IBR program is likely to be smaller than expected for several reasons. First, not all loans are eligible for the IBR program and borrowers who do not know the rules when taking out or consolidating loans will lose access to IBR benefits. Second, some borrowers will choose a 20-year consolidated loan over a 10-year loan that is eligible for reduced IBR payments. Third, most married borrowers will not choose to maximize IBR benefits by filling separate tax returns because this would increase their tax liability. Fourth, households with high levels of both student debt and other loans (non-secured consumer loans and mortgage debt) will often gain very little debt relief under IBR despite their high leverage.
The rules governing the discharge of student loans in bankruptcy are highly subjective. In most cases, even student debtors in extremely dire economic circumstances currently have a difficult time getting student loans discharged in bankruptcy. There is some variability of outcomes across courts. Since 2005, the stringent rules governing the discharge of student loans pertain to private student loans as well as government-backed loans. The decision as to whether to discharge student loans in bankruptcy should be based on an objective economic standard rather than the current “undue hardship” rule.
The 2005 bankruptcy law forced many student debtors to file chapter 13 rather than chapter 7. Student debtors are often only able to make minimal payments on student loans during their chapter 13 bankruptcy plan. The repeal of the chapter 13 means test would facilitate quicker repayment of student loans and benefit both student debtors and taxpayers. A rule that provides priority to student debt payments over other unsecured debt payments in chapter 13 bankruptcy would improve the status of student debtors and taxpayers and still leave creditors better off than they were prior to the 2005 bankruptcy law.
It is possible to provide a modest level of debt relief to student borrowers without imposing substantial costs on taxpayers either through the full implementation of the IBR program or through modifications of current bankruptcy rules.
- David Bernstein
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