Student debt forgiveness would do little for economy - Capital Economics
US Economics

Student debt forgiveness would do little for economy

US Economics Update
Written by Andrew Hunter

Even if a significant share of the $1.6trn of student loan debt owed to the Federal government was forgiven, it would provide only a limited boost to activity while driving a potentially sizable further increase in the budget deficit.

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  • Even if a significant share of the $1.6trn of student loan debt owed to the Federal government was forgiven, it would provide only a limited boost to activity while driving a potentially sizable further increase in the budget deficit.
  • President Joe Biden has long voiced support for student loan forgiveness and, although it wasn’t included in his $1.9trn fiscal plan, he was recently urged by Senators Chuck Schumer and Elizabeth Warren to cancel up to $50,000 in student debt per borrower via Executive Order. It isn’t clear if Biden has that authority and he appeared to pour cold water on that particular plan in public remarks on Tuesday, but he did reiterate previous comments that he would be prepared to write off $10,000 per borrower.
  • The value of student loan debt has risen rapidly over the past two decades, with the total owed to the Federal government now standing at just less than $1.6trn, or more than 7% of GDP, with an average balance of $34,000 among 46m borrowers. (See Chart 1.) Cancelling $10,000 of debt for every borrower would cut that balance to $1.2trn and eliminate the student loan debts of 15m borrowers, equivalent to a third of the total. The impact on government finances would depend on the value of the loans forgiven, but such a write-off could potentially add $400bn to the Federal budget deficit.
  • That said, there are two reasons why the economic impact would be much smaller than those figures suggest. First, the boost to borrowers would only be as large as the previous monthly debt repayments, not the overall value of the debt forgiven. Survey data from the Fed suggests that the average monthly repayment is about $250, or $3000 per year. So even if student debt was eliminated entirely, the annual income freed up to spend on other goods and services would only be worth about $140bn, or 0.6% of GDP. And given that Federal student loans are already subject to an interest-free repayment holiday, which Biden recently extended until the end of September, the immediate impact would be close to zero.
  • Second, even if forgiveness was limited to $10,000, a significant share of the benefits would flow to the highest earners. The larger costs for attending the likes of law or medical schools mean that above-average earners account for the bulk of outstanding debt, with the bottom 20% of earners accounting for just 5% of the total. (See Chart 2.) Moreover, because a growing share of borrowers are on income-driven repayment plans – where the size of repayments is tied to borrowers’ pay cheques and debts are forgiven after a 20- or 25-year period – the highest earners account for an even larger share of monthly loan repayments. With those high-earners more likely to save rather than spend any income previously used for student loan repayments, that would be another reason to expect any boost to economic growth to be small.
  • Admittedly, the boost to household net wealth might give some additional support to spending and the reduction in debt-to-income ratios could improve lower-income borrowers’ access to credit, potentially supporting auto and home sales. The Schumer/Warren proposal also called for Biden to take steps to limit the benefits to the wealthy, perhaps by restricting forgiveness to those earning below a certain threshold. But that would only mean that the economic benefits would be even smaller. The bottom line is that there are more effective ways to support the economy and to direct fiscal aid to those most in need.

Chart 1: Federal Govt. Student Loan Debt

Chart 2: Student Loan Debt by Income Quintile (%)

Sources: Refinitiv, Dept. of Education, Federal Reserve via Brookings, CE


Andrew Hunter, Senior US Economist, andrew.hunter@capitaleconomics.com