President Joe Biden, under extreme pressure from some of his constituents, has hinted at a possible student loan cancellation plan in the coming weeks.
He did not provide details, but hinted that anyone earning more than $125,000 would not be eligible for a pardon. He also said he was considering pardoning $10,000, but not $50,000 as other politicians have asked.
In light of this news, some finance experts are recommending people not pay off their student loans until more information is released.
Reasons given for forgiveness are to stimulate the economy and help low-income individuals and families.
And Democrats want to at least suspend reimbursement until 2023 to avoid angering their young voters ahead of the midterm elections. But that might not be a problem anymore because the possibility of Roe vs. Wade being canceled could make them think twice before threatening to stay home on Election Day.
A problem with loan forgiveness is that some people might waste it. Some people will neglect to repay their loans and accrue additional interest and penalties as a result. This accumulation, if neglected long enough, will increase to the point of nullifying the forgiven amount. Although this scenario may seem extreme, keep in mind that many people have not repaid their loans for two years due to the moratorium imposed and extended by the last two presidents. So, a number of these people will need to change their lifestyle and may need some motivation.
So if the government really wants to cancel student debt, it shouldn’t do it without asking questions. Instead, it should come with certain conditions that incentivize debtors to start repaying their loans. Here are a few that I would recommend.
Borrowers need to get out of default. Unfortunately, some borrowers have defaulted on their loans for one reason or another. As a result, they may be subject to penalties, their credit will be negatively affected, and they may even be subject to collection lawsuits and wage garnishments. If they want loan forgiveness, they have to rehabilitate their federal loans. Also, some should be counseled on checking their balance occasionally and how to avoid a default in the future.
Borrowers must enter into a repayment plan. This needs no explanation. Loan forgiveness should be a reward for those who start repaying their loans.
Government should provide matching credit for payments made. Rather than canceling the proposed amount in advance, the government should provide a matching credit for each payment made until the proposed cancellation amount is reached or the loan is repaid in full. The credit should be applied to the principal of the loan and not to penalties or accrued interest. For example, if a borrower pays $100, the government would have to forgive an additional $100 of the loan principal. It may also encourage some people to make larger payments to reduce long-term interest. An exception should be made for those with balances equal to or less than the proposed forgiveness amount – these people should have their loans canceled entirely without making any payments.
Income limits should be reconsidered. The $125,000 income limit President Biden imposed on pardons supposedly guarantees that only the truly indigent, not the wealthy, will be eligible for pardons. This might be fine if equity and wealth redistribution are the goals of student loan forgiveness.
But as noted above, the purpose of the loan forgiveness was to stimulate the economy and help Democrats maintain their majority in 2023. If those are the primary goals, the income limit will need to be increased. Indeed, $125,000 is considered middle-class income in some areas, especially in states with high income and sales taxes. These areas tend to vote Democratic, but they could feel alienated if they are excluded from loan forgiveness. Of those earning six figures, 42% said they live paycheck to paycheck, according to a recent survey.
Debt forgiveness is a sensitive subject. While some support it, others (including Liberal voters) oppose it. But if loan forgiveness is on the table, it should be implemented in a way that motivates borrowers to start repaying their loans and to do so in a financially responsible way. Otherwise, the remission will provide little or no benefit to those who default and accrue penalties and interest. And that could make inflation worse.
Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolves tax disputes. He is also sympathetic to people who have large student loans. He can be contacted by email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.