Is Student Loan Forgiveness an Effective Form of Economic Stimulus?
The economic crisis sparked by COVID-19 has reinvigorated a long-standing argument that forgiving student loan balances could help stimulate our wounded economy.
There are good reasons for Congress to relieve the burden of student loan payments during the pandemic, building on the six-month pause in payments included in the Coronavirus Aid, Relief, and Economic Security (CARES) Act. But evidence suggests canceling student loan balances would not be a cost-effective form of stimulus and would direct the most benefits to higher-income households. Congress can get more bang for its buck by targeting financial support to families most in need who are most likely to spend.
Forgiving student loan balances provides weak stimulus because most financial savings to borrowers show up in the future. A borrower paying off $30,000 of student loans—roughly the average amount for a college graduate—over 10 years would have a monthly payment of about $300. Forgiving $10,000 of that debt would free up $100 a month for the borrower to spend over the rest of the decade.
That long tail of payment reductions would do little to boost spending during the next year or two. Some borrowers might be more comfortable dipping into savings or taking on other kinds of debt, such as car loans and mortgages. But the immediate benefits would be modest, especially compared with sending each borrower $10,000 that can be spent right now.
In addition, many borrowers make payments based on their income, not their loan balances, by using income-based plans that limit student loan payments to a fraction of income (generally 10 percent). For these borrowers, moderate reductions in loan balances would generally not lower their monthly payments and would thus have no immediate stimulus effect. Any benefit would come later, in the form of paying off the loan sooner. Borrowers who pay nothing on their loans (because their income-based payments are zero or they are unable or unwilling to pay) would get no immediate benefit and would thus generate no direct stimulus. Some of these borrowers might spend more because their future loan payments are lower, but any effect would be spread over the remaining life of their loans.
Loan forgiveness is not well targeted at people most likely to spend. By definition, student debts are owed by people who attended college and, in most cases, graduated. Many of these people are struggling in today’s economic downturn. On average, though, they are doing better than people with less education. Households with graduate degrees hold nearly half of all student debt, despite making up only a quarter of households. On average, people with graduate degrees earn much more than people with less education. But evidence consistently finds that people with low incomes and income declines are the most likely to spend new resources. If policymakers want to stimulate the economy, they would do better providing financial assistance to low-wage essential workers than highly educated young professionals Zooming from home.
Student loan cancelation could be more targeted by wiping out the debts of borrowers with the lowest incomes or those who rely on safety net programs. There is compelling evidence these borrowers are most likely to struggle with their loans, despite having relatively low balances. This approach may be worth pursuing, but not on economic stimulus grounds because the benefit would be spread out over a long period of time.
Another strategy is to focus assistance during times of economic weakness. The CARES Act, for example, suspends federal student debt payments and waives interest accruals through the end of September. Congressional Democrats have pushed to extend that suspension. This eases cash-flow pressures during the suspension but does not reduce overall principal balances. Pausing or forgiving payments provides stimulus more cost effectively than forgiving loan balances because only short-term relief is provided, without the cost of forgiving balances that would be paid off years in the future. In principle, either of these approaches could be targeted to people with low and moderate incomes.
Even with these adjustments, forgiving student loan payments raises hard questions. If the goal is providing economic stimulus, why should a person with $30,000 in income and $1,000 in annual student debt payments get assistance while a person with $29,000 in income and no student loans gets nothing?
The CARES Act provided $1,200 payments to more than 90 percent of Americans, regardless of whether they have student loans. If Congress decides to provide additional economic stimulus, it could build on that structure, perhaps by focusing on people with lower incomes. Congress could also extend expansions in unemployment insurance, which provide benefits specifically to people who have experienced a drop in earnings.
Canceling student debt outright is a weak strategy for fiscal stimulus because it provides a slow drip of benefits over a long period of time. Forgiving payments during a limited time would be more cost-effective as stimulus, but it still raises concerns about targeting and about overlooking Americans who face similar economic challenges but do not have student debt.
A graduate wears a necklace made of dollar bills at the Pasadena City College graduation ceremony, June 14, 2019, in Pasadena, California. (ROBYN BECK/AFP via Getty Images)