Trump Faces Time Bomb in College Loan Program
What does the incoming Trump administration propose to do about the fast-growing, loss-ridden $1.3 trillion federal student loan system?
Unfortunately, senators barely touched on this issue at Tuesday’s confirmation hearing for Betsy DeVos, Donald Trump’s choice to be education secretary. In particular, they should have zeroed in on one target, the Public Service Loan Forgiveness program, a ticking time bomb set to go off this October.
PSLF is an extraordinarily costly “loan relief” plan that gives special treatment to people who go into public service, primarily people with expensive postgraduate degrees. Once activated, the program could potentially cost the taxpayers a staggering $84 billion, or even more, if you do the math.
“Public service” includes all government and nonprofit jobs, plus jobs in favored sectors of the economy including health care -- in other words, virtually anything other than work in America’s free-enterprise system, which pays the taxes that fund the public sector. Together, these public-service jobs encompass about one-quarter of the U.S. workforce, according to a recent Government Accounting Office report.
Currently, there are five different “income-driven repayment” plans in the federal student loan system. The public-service offering works in combination with whichever of the five programs the borrower chooses.
All of these income-driven programs reduce the borrower’s required payment to a percentage of income. If the borrower hasn’t paid off the remaining principal of the loan as of a certain date -- a date that is likely, if not intended, to come well before the loan has been fully repaid -- the remaining balance is forgiven. In other words, these two features work together: Limiting the monthly payment to a percentage of a worker’s income pushes principal amortization out toward the end of the loan, with a potentially significant portion of it left in the taxpayers’ lap after the date of forgiveness.
Given the generous relief terms, people have been flocking to these income-driven plans. According to the recent GAO report, about 5.5 million borrowers with about $270 billion of outstanding loans have enrolled in income-driven repayment plans as of June 30, 2016.
The Obama administration introduced the latest one in 2015. Called Repaye (“Revised Pay As You Earn”), it reduces loan payments to just 10 percent of the debtor’s “discretionary income” and provides loan forgiveness after 20 years.
The public-service component, which started taking applicants in 2007, is even more forgiving.
Once they are accepted into an income-driven relief plan, borrowers working in “public service” are entitled to loan forgiveness after making just 120 monthly loan payments -- 10 years. So those people who signed up in 2007 are set to have their remaining debt forgiven this October. About 450,000 have already enrolled in PSLF on a provisional basis, under a voluntary pre-certification plan. Given the broad definition of “public service,” however, about 1.4 million borrowers currently in income-driven plans might qualify for PSLF.
In its report, the GAO analyzed the public-service option by looking at a typical borrower who is single with no children. His loan balance is $60,000, which is the median for the borrowers already certified for the program. This median amount is a tip-off that graduate students represent the majority of those certified for the plan, since undergraduates may borrow no more than $31,000 in federal loans over five years. Graduate students can take out unlimited federal loans.
The GAO assumes that its typical borrower has an initial adjusted gross income of $40,000 a year that rises gradually thereafter. Since “discretionary” includes income only above 150 percent of the poverty line (above $18,497 for a single with no dependents), his initial discretionary income is only about $21,500, yielding an initial annual loan payment requirement of only $2,150.
Under PSLF, he pays for 10 years, just as he would have under the original terms of his loans. However, under the original terms, using a blend of current undergraduate and graduate loan interest rates (4.75 percent), his annual payment would be three and a half times higher, about $7,550, which would fully pay off his loan. In contrast, even though his income is assumed to rise over the 10 years (at 5 percent annually, net of a 2.3 percent annual poverty line increase), the PSLF borrower winds up with loan forgiveness roughly equal to his original $60,000 loan balance. From the taxpayers’ point of view, the loan is a total loss.
Debt forgiveness of roughly $60,000 translates into a stunning $84 billion when replicated for the 1.4 million borrowers who are potentially eligible for the public-service program.
And $84 billion may be a low-ball estimate. Remember that $60,000 is only the median loan balance of current PSLF applicants. Thirty percent of them have loan balances exceeding $100,000. The entirety of that extra $40,000 (plus interest) will go unpaid as well, because there’s no cap on the amount that can be forgiven.
Indeed, the program is likely to generate an even greater bill for taxpayers, because of its perverse secondary effect. By delivering even more free money to universities, they can raise graduate-school tuition knowing that the customer, the grad student, can borrow the entire amount and never have to pay any back. The almost inevitable spikes in graduate-school tuition will act to defeat the main goal of loan relief. Higher tuition will lead to more student debt and more and more loan forgiveness. At every stage of this vicious cycle, a greater burden will be placed on taxpayers.
The new Trump administration should be concerned both at the cost involved and the way PSLF steers our most highly educated workers away from the real economy and into big government. That won’t promote economic growth -- just the opposite.
What to do? At a minimum, the Trump administration should close the program for loans originated after 2016.
Since borrowers who took out loans between the time PSLF was created in 2007 and 2016 may have made decisions based on reliance on the program, it would be difficult to deny them some debt forgiveness (not to mention that many of them graduated during the Great Recession, when employment prospects were bleak).
But relief for future graduates is just free college and graduate school delivered at the back end. If we want to reduce the cost of higher education, we should enact policies that reduce the price at the front end in full view of the public, only after open debate, not via complex back-end relief programs. After all, nothing is free. Someone always pays.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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