Canceling student debt for everyone is bad policy and bad economics

Recent reports indicate that the Biden administration is considering canceling some student loan debt. At $1.7 trillion, the amount of student debt is astronomical. This is 30 times the entire budget of the U.S. Department of Education in 2022. Extravagant spending warrants extraordinary scrutiny, and such expensive policies demand a careful consideration of who benefits from this spending, and what else could be done with such a massive expenditure.

Our research shows that student loan forgiveness primarily benefits affluent borrowers. Full cancelation would distribute $192 billion to the top 20 percent of earners, and only $29 billion to the bottom 20 percent — meaning that for each dollar given to the bottom fifth of earnings, more than $6 are given to the top fifth of earners. Economists overwhelmingly agree that student loan forgiveness is a regressive policy that disproportionately benefits high earners.

The reasons for this are clear: Those who go to college and acquire student debt earn more than those who didn’t go to college, and those who spend more years in college and borrow for more years – such as doctors, lawyers and Wall Street analysts – earn more than those who spent fewer years, such as dropouts and vocational degree holders.

This problem is well known to policymakers, so current loan forgiveness proposals suggest two fixes. First, proposals suggest capping forgiveness amounts at a certain amount, such as $10,000, and second, plans suggest capping incomes of borrowers eligible for forgiveness. But these schemes do little to address the fact that the majority of benefits will go to upper-income households.

Let’s dig into these proposed modifications to loan forgiveness. For the first proposal, capping forgiveness at $10,000, most of the dollars from loan forgiveness go to high-earners and will not benefit many lower-income borrowers with large loan balances. This is because lower-income borrowers will already see forgiveness through existing programs like income-driven repayment.

These income-linked plans tie a borrower’s payments to his or her income. Low-income borrowers pay little or nothing and see forgiveness after a certain number of years. The amount that would be forgiven under existing income-driven repayment rules is the one that immediate partial forgiveness would cancel first.

For example, consider a low-income borrower with $15,000 in debt who would repay only half this amount under current rules. Reducing this borrower’s balance by $10,000 would translate to only $2,500 of additional payment savings. That is because the remaining $7,500 is redundant with existing programs. On the other hand, each dollar of forgiveness going to high earners is taken from debt they would have otherwise repaid.

The second proposal, capping incomes of borrowers eligible for forgiveness, is also highly regressive because it does not factor in lifetime earnings — only earnings at the point and time that the forgiveness kicks in. On average, individuals earn more as they age and this is particularly true in many professions that accrue high levels of debt, such as the medical and legal professions. Medical residents and law clerks would benefit from loan forgiveness, despite earning tremendous amounts over their lives and in many cases entering the top 1 percent of earners. Moreover, many borrowers are still in school or only worked for a portion of the tax year and would receive forgiveness regardless of the high salaries they can expect when they graduate. Therefore, a future surgeon would receive the same debt forgiveness as a future public-school teacher, regardless of their earning potential.

Can we design a system that provides relief to low-income borrowers without spending hundreds of billions on doctors, lawyers and other high earners? It turns out that such a system already exists through income-driven repayment.

These plans link borrowers’ earnings to their income. Borrowers who earn below a certain level pay nothing. Borrowers also pay less when they are younger and earn less and pay more when they are older and their incomes rise. In many ways, income-driven plans are similar to a progressive tax system. One way of providing more relief to low-income borrowers is simply to make income-driven plans more generous, as the Biden administration has begun doing. Relief could also be given to borrowers through reintroducing bankruptcy, administrative discharge or expanding loan cancelation for victims of predatory for-profit colleges.

In the long term, every dollar spent on student loan forgiveness means that the government will need to either raise taxes by an equivalent amount or cut funding from other important government programs that many poor families rely on. And there are many other programs in strong need of funding.

For example, the Washington Center for Equitable Growth estimates that spending $200 billion could provide free high-quality preschool to all three- and four-year-olds for 10 years. This is a small fraction of proposed spending on loan forgiveness benefitting the well-off, and research shows that early childhood education is among the most impactful investment governments can make.

Student loan cancelation is a tremendously expensive policy. It is undeniable that many borrowers are sympathetic candidates for relief. But we do not need to spend hundreds of billions of dollars to target borrowers who could enter the top 1 percent or 10 percent of earners. We can target relief to the borrowers who need it the most, and instead spend scarce funds on other vital programs like early childhood education.

Sylvain Catherine is an assistant professor of finance with the Wharton Business School at the University of Pennsylvania. Constantine Yannelis is an assistant professor of finance and FMC Faculty Scholar at the University of Chicago Booth School of Business.