Tim Tai/The Philadelphia Inquirer via AP
Graduates wait in line to cross the stage during La Salle University’s Class of 2021 commencement at Lincoln Financial Field in Philadelphia, May 15, 2021.
Much of the debate about student loans is framed in terms of financial statistics. We hear that we have $1.6 trillion of debt outstanding, or that the income-driven repayment programs might cost taxpayers $100 billion or more, or that there’s a $500 billion “hole” in the system, or that canceling $50,000 of debt per person might cost $1 trillion. Estimates like these purport to frame contested policy choices in terms of hard dollars, with the clear inference that policies like one-time student loan cancellation or expanded income-driven repayment programs are simply unaffordable.
There’s only one problem: These numbers are made up. They are mere artifacts of a series of policy and modeling choices, with little basis in the reality of personal or public finance, or the costs and benefits of higher education. There are real dollars involved, to be sure, but quoted dollar amounts like those above are based on a lie—really a series of lies.
This matters because the policy choices we make now will transform these fake numbers into real ones. If the law demands repayment of $x from a student borrower, that becomes a very real cost that can impact their life for decades or longer—even if “x” is a made-up amount. The legal institutions and moral obligations of debt have significant power to turn hypothetical cash flows into real obligations, without us even realizing what’s happening.
WHAT ARE THE LIES that lead to these fictional numbers? First, the calculations of overall student debt treat the cost of a student’s education as equal to a school’s net tuition charge, even though net tuition is a highly variable number across schools and students. Second, the government inflates the amounts borrowed using arbitrarily high interest rates subject to a series of deeply complex and opaque rules. And third, federal budgeting uses a “cost” methodology that grossly overstates how much taxpayers will pay for student loans, and masks that the government is likely still making a profit from them, even those that they may someday cancel.
To break this down, let’s follow an example. Mark is a law student who owes $50,000 per year in tuition, and he uses a combination of Direct Loans and Grad PLUS loans to pay it (he may also need to borrow more to cover living costs, but let’s put that aside). But what does that tuition number represent? Only part of it is the cost of paying for the education he actually receives. Some of Mark’s tuition payment will subsidize grants and financial aid for other law students. And law schools that are part of universities can contribute 30 percent of their revenue or more to the rest of the university. This means that some of Mark’s loan proceeds are also being used to subsidize undergrads and less profitable departments. Simply put, schools fund a large part of their operations on the backs of full-paying (and full-borrowing) students. In essence, Mark has unwittingly agreed to become personally liable for money used to help fund the entire higher-education sector.
But at least tuition dollars reflect the real costs of higher education, even if not the cost of educating Mark in particular. But what happens next is just the engineering of additional debt out of thin air, with little relationship to the cost of educating Mark, or anyone else.
Let’s say Mark graduates with $150,000 in debt. As he attends school, it has already been accruing interest. For Grad PLUS loans, the current interest rate is 6.3 percent, set by statute to be 4.6 percent above the ten-year Treasury note yield. This rate has little to do with the specifics of Mark’s creditworthiness; it is hard-coded into the law to create profit for the lender (which since 2010 has always been the federal government).
In fact, Mark will be paying the highest rates of any student borrower. Interest for Grad PLUS loans are set by law at one percentage point higher than other Direct Loans, not because they are higher-risk loans (they aren’t), but because legislative drafters have over the years tweaked the interest rate formulas until they got the revenue they needed to satisfy budget-scoring rules. As a result of these arbitrary interest rates, the student loan program has generated a profit to the government of as much as 10 percent or more on the average loan.
Student debt figures are mere artifacts of a series of policy and modeling choices, with little basis in the reality of personal or public finance.
Not only is the stated interest rate arbitrary; it’s also unlikely to be the interest Mark actually pays. There are many ways for interest to be tweaked, subsidized, and waived on federal student loans, particularly through any of the income-driven repayment (IDR) programs. These complex and opaque rules mean that it is impossible for a borrower or the government to know how much interest will actually be paid, which underscores the arbitrariness of statutory interest rates.
Because of Mark’s high debt, he’s likely to enter one of the IDR programs, which generally require borrowers to pay 10 percent of their discretionary income for 20 years, at which time any remaining debt is canceled. As Mark goes on in life, he’ll pay the Education Department that fixed 10 percent of his discretionary income, and his total debt will grow or shrink based on those payments and the complicated interest rules. Under this system, it’s likely that some of what Mark owes the government is already being canceled, on a monthly basis, under current law—a fact that raises barely an eyebrow, compared to the heated debates around a one-time cancellation of debt principal.
So how does the government treat the revenue from federal credit programs like student loans? First of all, it does not simply count the dollars actually repaid annually as revenue. Instead, at the time each loan is made, the government executes a complicated calculation that balances the amount loaned against how much the government expects to get repaid, including interest, and books all of that expected profit (or loss) as revenue (or outlay) immediately. (In federal credit parlance, this is known as the loan’s “subsidy rate.” Loans that are estimated to earn a profit—like many student loans—are deemed to have a “negative subsidy rate.”)
Because student loan payments take place over years if not decades, the government discounts future payments to present value. But it does so using a discount rate that is much less than the loan interest rate. The effect of all this is that the government’s expected 4.6 percent annual profit over the full life of a student loan—the statutory spread above its borrowing rate—gets entirely booked as revenue in the first year of the loan. In each subsequent year, the government revises its estimate of the subsidy rate, and books additional revenue or outlays as its estimate of profit goes up or down. If in a future year, loan repayment estimates are lowered, because of new repayment plans or partial loan cancellation, that would show up as a new government outlay in that future year.
This is confusing stuff, so let’s put some numbers to it. Imagining this as a single $150,000 loan, this methodology would mean that if the government expected Mark to fully repay his loan over the standard ten-year repayment term, it would estimate receiving, in discounted present value, about $188,000. Therefore, the government would immediately record $38,000 as revenue in the first year of the loan (the difference between $188,000 and the original loan amount). Then suppose next year Mark signs up for IDR. Now the government anticipates lower monthly revenue and some chance of ultimate forgiveness. (To be clear, these annual re-estimates are done at the loan portfolio level based on the Education Department’s model, not at the individual borrower level—but choices like Mark’s will affect the variables used in the model.) Let’s say Mark entering IDR lowers the present value estimate of the loan to $160,000 (it may not; extending loan payments for 20 years with high interest could increase the government’s profit if Mark is likely to be a high earner in future years). Federal credit rules would then treat this as a budgetary outlay of $28,000 in the second year of the loan—a “cost.” But all we’ve really done is lower an estimate of government profit.
In other words, just as Mark has borrowed money from the government, the government has also borrowed from Mark, immediately spending the expected future profit from his loan. If the government ends up earning somewhat less from Mark’s loan than originally hoped, that’s a “cost” only in the sense that budget officials counted their chickens before they hatched.
Finally, if Mark makes less than about $100,000 per year, his IDR payments would only cover 6.3 percent annual interest. If he only pays the interest, total payments over 20 years will equal about $189,000. And if IDR payments are not enough to cover the interest, the unpaid loan balance will continue to grow (even at a subsidized interest rate). Mark very easily could end up making payments that exceed the $150,000 he originally borrowed, while still ending up with a greater loan balance than when he started. And if all he ever pays is interest, it will seem as if he never paid any of the original loan back.
In that scenario, the government will have made a profit off Mark, even as his loan increases the $1.6 trillion total outstanding debt. Mark’s share of that $1.6 trillion is just a hypothetical higher profit for taxpayers. Furthermore, under federal credit accounting rules, the government probably already lowered those profit expectations and booked the cost accordingly. To sum it up, if we canceled all student debt tomorrow, taxpayers would not lose $1.6 trillion, nor would that be the budgetary cost. In other words, $1.6 trillion is a made-up number with little connection to any budgetary reality.
DOES THIS MEAN we must cancel all student debt? You could argue that, given the clear financial benefits of higher education it is reasonable to ask students to bear some of the cost of that education. You could also argue that, given the clear benefits to the country of an educated population, the government should make that investment in the public interest.
But what is definitely not reasonable is saying that there is a moral obligation for Mark and his fellow students to pay every last dollar of nominal debt, when many of those dollars are based on arbitrary policy decisions made for reasons independent of the true cost of educating them. Like much of our hidden welfare state, our system of loan-based higher-education finance is a complicated basket of policy instruments serving multiple purposes, not just paying for a particular student’s education. But the legal and moral language of debt can mask all of that behind the false precision of a dollar amount that is largely divorced from the actual costs, or even actual amounts loaned. Perhaps we should spend less time talking about what Mark owes, and more time talking about what we all owe to each other.
