How wiping out all student loan debt would change the economy

BY Rich GrisetJanuary 03, 2022, 7:17 PM
Activists and artists call on President Biden to cancel student debt near the White House, as seen in December 2021 in Washington, DC.
Activists and artists gather near the White House in December 2021, calling on President Biden to cancel student debt.
Paul Morigi—Getty Images for We, the 45 Million

Since taking office last year, President Joe Biden has announced the cancellation of $11.24 billion in student loan debt. That figure may sound high, but it actually accounts for less than 1% of the estimated $1.75 trillion of existing student loan debt in the United States.

Recently, prominent Democrats have proposed varying levels of student loan debt forgiveness, with U.S. Rep. Alexandria Ocasio-Cortez recommending cancellation of all student loan debt, while Senate Majority Leader Chuck Schumer and Sen. Elizabeth Warren have proposed canceling up to $50,000 per borrower; Sen. Bernie Sanders, an independent who maintains a close relationship with the Democratic Party, also supports universal debt cancellation.

On the 2020 presidential campaign trail, then-candidate Biden promised to cancel $10,000 per borrower upon taking office. Biden has targeted debt relief at specific groups so far, including borrowers who are public servants and those with permanent disabilities. 

Providing $10,000 in relief to the country’s 43 million existing borrowers would cost an estimated $373 billion, according to the Brookings Institution. While borrowers may be happy to have their debt forgiven, experts say the expense of widespread efforts to reduce or wipe away student loan debt may not provide much of a boost to the broader economy.

Who holds student loan debt?

Student loan debt is primarily held by borrowers who were raised in higher-income households and now live in higher-income households. According to Brookings, in 2019 only 7% of students who would benefit from student loan forgiveness were living below the poverty line. People who held any student debt lived in households with a median income of $76,359, compared with the national average of $69,560; people who were making payments on their student debt had a median household income of $86,540.

“People who go to college, and graduate from college, are often in much better economic and financial shape than everybody else,” says Adam Looney, a nonresident senior fellow at Brookings who worked on student loan debt proposals in the U. S. Department of the Treasury during the Obama administration. “They’re better educated, they’re from more affluent backgrounds, and they earn more income.”

More prosperous, advantaged, and whiter than the public at large, this group generally has more disposable income, especially if they attended graduate school. According to a 2019 report from bond credit rating business Moody’s Investors Service, 63% of student loan debt at the time was held by households in the upper half of U.S. household income. 

Still, student loan debt has ballooned. In that same 2019 report, Moody’s stated that student loan debt had doubled in the prior 10 years, growing faster than any other category of household debt. All of this has been impacted by higher college enrollments, rising undergraduate costs, an increase in borrowing, and a reduction in state funding to public four-year institutions.

And there are downsides for Americans who take on too much student loan debt, including weaker creditworthiness, reduced consumption and investment, and widening income and wealth inequality. This debt can hold people back from making decisions that would benefit the broader economy, such as buying a home, having children, and starting businesses.

There’s also concern that holding student loan debt takes a mental toll on borrowers beyond strictly financial worries.

“People clearly feel like there’s this huge psychological cost of student debt where they agonize over the balance and worry that it impairs their long-term prospects,” Looney says. 

What student loan debt relief means for borrowers

In the conversation over canceling student loan debt, Warren is one of the most strident voices. She argues that Biden has the power to cancel student loan debt on his own without the help of Congress—citing evidence presented by Toby Merrill, the cofounder and former director of the Project on Predatory Student Lending who is now deputy general counsel for the Education Department’s Office of the General Counsel.

“Student loan debt is holding back tens of millions of people across this country who can’t buy homes, buy cars, or start small businesses,” Warren tweeted on June 13, 2021. “President Biden needs to #CancelStudentDebt not only for those people individually but also for our whole economy.”

But the economic impact of student loan debt relief varies depending on the amount of relief provided and whom it targets. Broadly, Moody’s holds that various forms of student debt relief would act like a tax cut stimulus to economic activity, leading to a modest increase in household consumption and investment. Long term, a reduction in student loan debt could help improve the formation of small businesses and households, as well as spur an increase in homeownership.

Blanket student loan debt forgiveness would mostly benefit people who would have likely paid off their loans over the long term. The Federal Reserve Bank of New York estimated that the average monthly loan payment in 2018 was between $200 and $299. While that extra cash would certainly be helpful to a college graduate’s finances, in the end, it would probably just add to their household’s disposable income. And because the households of college graduates are more affluent, they’re more likely to save that extra money than spend it on necessary items, blunting its impact on the economy at large.

William Foster, Moody’s lead sovereign analyst for the U.S. government, warns of the “moral hazard” of widespread student debt relief.

“You risk, somehow, creating a moral hazard, meaning that perhaps future students who didn’t benefit from the debt forgiveness today would expect debt forgiveness in the future,” says Foster, vice president and senior credit officer at Moody’s. “They would then, as a result, not worry as much about the debt they’re taking out because they’re expecting it to be forgiven in the future.”

Stimulus funds from the pandemic have added a complicating wrinkle when it comes to the student loan debt conversation. In December, Biden extended the student loan payment freeze until May from February. Meanwhile, there was a backdrop of more generous unemployment benefits and rising wages that resulted in many people saving more money—and Foster says many households have a better financial footing than they did pre-pandemic.

The big question that remains is what happens once the forbearance for student loan payments is phased out, Foster says. “What’s going to happen to people’s behavior, and, ultimately, what’s going to happen to the ratios [economists follow to understand student loan debt]?” 

What student loan debt forgiveness means for the economy

Both in its scale and in its cost to taxpayers, widespread student loan debt forgiveness in any form would be one of the largest transfers of wealth in American history. Brookings reported that forgiving all federal student loans would cost an estimated $1.6 trillion as of February 2021; a blanket one-time $10,000 to borrowers would cost about $373 billion.

A transfer of wealth of these magnitudes would have a positive effect on the economy, but the “bang for the buck is quite low” compared with other, more progressive endeavors, says Looney, who’s also a professor of finance at the University of Utah. Because people with student loan debt generally earn more money, they won’t benefit as much from relief as other groups would.

“The economic effects of debt forgiveness are exaggerated,” says Looney, whose study of the issue finds that even $10,000 in debt forgiveness would cost roughly as much as the country has spent on food stamps since 2000. He suggests that continued targeted student loan relief efforts, such as additional assistance to borrowers who were Pell Grant recipients, might have a broader impact; Pell Grants are issued to students who demonstrate financial need.

According to Moody’s, universal student loan debt cancellation would only marginally increase the U.S. government’s debt burden and lead to forfeited revenue to the government equal to 0.4% of GDP annually. As of 2019, the vast majority of the $1.2 trillion in student debt owed to the federal government was in the form of direct loans, forgiveness of which wouldn’t add to the country’s debt stock. Direct loans are funded by U.S. Treasury bonds and are already incorporated into the debt America owes at the time of origination.

Even if the government purchased and subsequently canceled the $402 billion in privately held student loans, it would only add about 2% GDP to the national debt burden. If universal debt relief were enacted, Moody’s estimated in 2019 that it would widen the national fiscal deficit by 0.4% of GDP within the following decade, up from an estimated 6.3% to 6.7%.

Looking at the topic broadly, Looney says that while some borrowers pursued programs that weren’t worth the debt they took on, most college degree recipients get a great deal in exchange for their investment of time and money. 

“There is no other financial investment that you can make that yields the same economic payoff, in terms of job prospects and how much you earn—your cumulative life success,” Looney says. “I’m worried that we’re going to try to impose these one-size-fits-all solutions and throw the baby out with the bathwater, when instead we should be much more nuanced in how we issue student loans in the future, and how we deal with those who have already borrowed.”

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