Student loan "forgiveness" is a fallacy because the government makes too much money

One of the issues Hillary Clinton has tried to push in her presidential runs is the idea of “debt free college.” Clinton claims her plan will be “fully paid for” by “limiting certain tax expenditures for high-income taxpayers,” and makes a bevy of other pleasant sounding promises about tuition.

Eliminate college tuition for working families. Families with income up to $125,000 will pay no tuition at in-state public colleges and universities – covering more than 80 percent of all families. From the start of this plan, every student from a family making $85,000 a year or less will be able to go to a 4-year public college or university tuition free. This income threshold will increase by $10,000 a year every year over the next four years so that by 2021, all students with a family income of $125,000 will have the opportunity to pay no tuition. She will also continue her commitment to ensure that community colleges are tuition-free for all working families.

Help students deal with all of the costs of attending college.  Hillary Clinton will protect Pell Grant funding to help low- and middle-income students pay non-tuition expenses, and she will restore year-round Pell Grant funding so that students have the necessary support they need to take summer classes and meet their goal of completing college.  She will make a major investment in HBCUs, Minority-Serving Institutions and other low-cost, modest-endowment private schools so that these deserving students also benefit from the lower cost of college. She will work to expand opportunities for students to earn money for expenses through term-time work and to receive college credit for national service. She will expand support for student-parents, including a fifteen-fold increase in federal funding for on-campus child care.

Clinton also wants a three month moratorium on student loan payments, which sounds awesome, right? There’s just one problem: the federal government profits too much from student loans for a “three month moratorium” to make an actual dent in the amount of cash students pay for loans. Scott Burns at The Dallas Morning News writes the federal government actually collects taxes on student loans (emphasis mine):

The hard part comes when the graduate has to pay back student loans. Why? Because it is done with after-tax income. While interest payments up to $2,500 a year may be deductible, principal repayment is not. So if you are in the 66 percent of people who graduate from a public college with debt and have average debt, you’ll owe $25,550 of after-tax income. With a marginal tax rate of 25 percent, that means you’ll pay back $34,067, a nice $8,517 premium for Uncle Sam…

Now let’s do a back-of-the-envelope calculation. According to the student loan debt clock, the current level of student debt is $1.435 trillion. So if Uncle Sam pulls in taxes on this amount, the total students will have to pay back, tax premium included, would be $2.13 trillion. Again, that’s an added tax premium of nearly 50 percent, about $700 billion.

See how Clinton’s promise of “debt free college” is a load of bull-turds? Clinton could require everyone making over $250K a year to pay some sort of “student loan tax,” and the student debt issues would still exist. I wrote last year how Jeb Bush’s idea of requiring universities to pay back students who take longer than four years to graduate was a bad idea because of the government’s role in student loans. A Federal Reserve Bank of New York study on the relationship between government-backed student loans and tuition increases agrees:

From the second stage, when we control for all forms of aid, we find that each additional Pell Grant dollar to an institution leads to a roughly 55 cent increase in sticker price tuition. For subsidized loans, we find a somewhat larger passthrough effect of about 70 percent. We also find a loading of tuition on unsubsidized loans of 30 percent. All of these effects are highly significant and are consistent with the Bennett Hypothesis. We further control for changes in other revenue sources at the institutional level, and the possibility that certain institutional characteristics may be correlated with both these changes and with tuition changes. We find that the subsidized loan effect is quite robust across specifications both in magnitude and significance, while the Pell Grant and unsubsidized loan effect are less so.

There are a couple solutions to how the federal government could get out of the way of student loans. Burns suggests making them tax deductible, much like small businesses do for expenses. He thinks it would give students a “better start” and would shrink the amount of debt they’re addled with. It’s a possible solution, but the “best one” is completely changing how the federal government operates from both a tax and a student loan standpoint. The federal government should start decreasing the amount of student loans it hands out per year, until it’s completely out of the loan business. I’m not sure how long that will take (maybe ten, maybe 20 years…maybe only five). The government should also start decreasing the amount of cash it hands out to universities per year. This allows public universities to start adjusting their own spending habits so they aren’t caught by surprise when all the federal money is gone. On the tax front, the government needs to reduce the corporate income tax to zero, do major cuts in government spending, and other tax overhauls so more people can keep their own money.

The biggest issue with my ideas is people are going to have to be patient. As much as I’d love to just immediately slice something off, it’s not the wisest of moves. Of course, the flip side is the fact the federal government never really seems willing to go through with spending decreases. It’d take a strong show of spine by fiscal conservatives and libertarians in and out of Congress (and in state legislatures) to make sure the government doesn’t renege on its promise of spending cuts. It also requires people to be willing to be patient and ride out of the storm when complaints start rising up. Fiscal sanity matters. It just depends on if people (and governments) are willing to show it.