I often discuss explicit taxes on thrift, such as taxes on capital income. Many of these taxes discourage saving by applying a higher tax rate on future consumption than current consumption. But there are also many hidden taxes on thrift, as when government benefits are denied to people on the basis of a lack of “need”.
Many recent college grads are about to get a $10,000 gift from the federal government. My daughter won’t receive that gift, because her parents were thrifty and hence she did not borrow money to go to college.
Today, I feel like a sucker. If only I’d encouraged her to borrow $10,000 for college. I guess public choice theory is not my forte, as I never saw this coming. I wonder if Bill Gates was smart enough to have his kids borrow $10,000.
There are many other examples of government benefits that are based on “need”. I use scare quotes for need because in almost all cases the criterion is not truly need, it’s at least partly related to thrift. And because (on average) the total lifetime earnings of college students exceeds the earnings of those who didn’t go to college, it’s not obvious that debt forgiveness has any merit on “equity” grounds. As for efficiency, this policy not only reduces the incentive to save, it encourages colleges to be less careful about holding down costs.
READER COMMENTS
Mark Barbieri
Aug 24 2022 at 6:10pm
To me, the most bizarre thing about this is that they are forgiving older loans but not recent of future loans, but they haven’t changed the process that got us here at all. How long will it take for another round of “forgiveness”? Probably just in time for the next election.
Johnson85
Aug 25 2022 at 12:43pm
I think the bizarre thing is that this is structured to only help people that don’t need debt forgiveness. If you really have burdensome student loan debt, you are on an income repayment plan, and you are on path to get your debt forgiven. Knocking $10K off the principal isn’t going to really change how much your monthly payment is, it’s just going to show it being forgiven now rather than in 10 or 20 years (depending on what you qualify for).
I have not checked, but somebody said it also prohibits interest from being more than the income based repayment amount, so balances can no longer grow if people are at least paying the income based repayment amount. If that’s the case, I guess it makes it easier for people that have a big increase in income to pay it off early if the income based repayment becomes high enough that it makes sense to go ahead and pay it.
michael Thomas
Aug 24 2022 at 6:53pm
My son just started his Freshman year at Purdue. Purdue has kept its costs flat for the past 11 years. It seems to have done this while maintaining (or perhaps even improving) its reputation.
I cannot understand why every major media outlet hasn’t written in-depth examinations of how Purdue has managed to pull this off. Why is this not a model that other institutsions seek to understand and emulate? Instead, we spend endless cycles discussion “fogiving” debt.
(At least part of the story involves not spending lavish sums on Club Med-style dorms and making students go to class at 7 am in the morning – hardly bad things, I think!)
Matthias
Sep 4 2022 at 7:09am
That’s not the business major media outlets are in..
They need to drive engagement to drive clicks and ad revenue. Not educate people about the best policies.
Jose Pablo
Aug 24 2022 at 9:02pm
I love the “saddled with unsustainable debt.” part.
If the debt you incurred in to pay part (not all) of your education is “unsustainable”, what is the value of your education?
It has to be less that what you pay to get it, right?
Where I am wrong?
1.- The “value” of your education is the discounted value of the “earnings premium” that your education should allow you to get in the future.
2.- If your “earnings premium” does not allow you to repay your debt it should mean they have less value than your debt.
3.- So, your education is less valuable that the “financed” part of what you paid for it.
[The whole rational is “conservative” since you can use some of the “earnings premium” of your debt free high school education to repay your college debt]
And Biden says that there is a significant number of college students in this situation. And that the solution to this is giving students additional incentives to pursue this waste of time in college.
Maybe Bryan Caplan is right after all …
Jose Pablo
Aug 24 2022 at 9:12pm
The other thing that gets my attention is this “cap at 5% of monthly income” (I hope this “monthly” part is not coming from Mr. Biden and was added by the journalist … once you fix the cap as a percentage rate, the “monthly” part is “irrelevant”)
Let’s imagine a starting salary of $50,000 for a college graduate. On that income you have to pay 14% ($6,800) in income taxes, but your debt repayment will be capped to $2,500 per year due to “sustainability issues”.
So, paying taxes of 14% of your income is “sustainable” but repaying debt of, let’s say, 6% of your income is not?
[By the way, the 5% limit apply to your gross or your net income?]
Komori
Aug 25 2022 at 12:08pm
Yeah, the per-month part isn’t in the original announcement.
This is such a bad idea.
https://boriquagato.substack.com/p/control-the-lending-control-the-schools
Thomas Lee Hutcheson
Aug 24 2022 at 9:47pm
If we wish to encourage thrift, and we should, the way to do it is not on the basis of the source of income (“capital” “labor”) but it’s use going forward. Raise the amounts that can be invested tax free in retirement accounts or other non-consumption vehicles so that the income is taxed only when consumed.
Jose Pablo
Aug 25 2022 at 11:36am
“Capital” is “labor income” that has been saved.
There is no such a thing as “tax free invested capital” since all “capital” was already taxed as “labor income”.
What you really mean is “can be invested double taxing free in retirement accounts or other non-consumption vehicles so that the income is tripled taxed only when consumed”.
Jose Pablo
Aug 25 2022 at 11:51am
“… is not triple taxed when consumed”
Scott Sumner
Aug 24 2022 at 10:43pm
Everyone, All good points.
BC
Aug 24 2022 at 11:42pm
This is like the government defaulting on its debt, except in reverse. When government defaults on paying back debt, lenders become reluctant to lend more to government. When government defaults on collecting debt, borrowers become reluctant to pay back government. People don’t want to become “suckers”, either lending to a government that doesn’t pay back its debt or unnecessarily paying back debt that later ends up being forgiven. We should probably say that Biden defaulted on collecting college debt rather than saying that he “forgave” debt. He defaulted on the government’s promise to taxpayers that they wouldn’t be left holding the bag on all this college debt.
People that normally would have repaid their loans now have to consider that, if they repay all of their loans quickly and the government defaults on debt collection again in the future, then they’ll end up paying more for college than necessary. On the other hand, if the government doesn’t default on collection again, then they might wish later that they had repaid their loans sooner to avoid all the interest charges. By introducing uncertainty over whether government will actually collect debt, Biden is adding unnecessary risk to future borrowers just as uncertainty over whether government will repay its debt adds risk to future lenders.
Here are some more ways that collection default creates perverse disincentives: enlisting in the military to earn college tuition on the GI Bill and going to a cheaper in-state public university to minimize college debt. Some people that would have done these things now have to think twice about becoming “suckers”, about unnecessarily minimizing debt that the government doesn’t actually end up collecting.
Just as it’s very difficult for government to re-establish creditworthiness after defaulting on paying back debt, it’s also difficult for government to re-establish collection-worthiness after defaulting on collecting debt. In fact, the more people that refrain from paying back college debt in the future over collection default concerns, the more political pressure there will be for the government to default on collection again. How can the government now credibly promise to collect debt in the future?
Brandon Berg
Aug 25 2022 at 4:53am
Worth noting also that about 15% of student loan debt outstanding as of early 2020 has already been cancelled via a combination of inflation and interest-free forbearance.
Michael Rulle
Aug 25 2022 at 8:03am
I am surprised there are not more complaints about the University System rip off. Admittedly, the very wealthy private universities do provide tuition and room and board discounts of a significant amount—-still, the average Harvard student leaves with 20,000 of debt. Harvard, however, gets that cash regardless. Pell Grant recipients for political reasons will get 20,000 (not 10,000) knocked off their owed debt. Pell Grants are “grants”—-yet they get more. So Mr or Ms Average with a Pell Grant at Harvard gets their debt knocked down to zero—-but Harvard still gets the cash.
The less wealthy colleges and Universities always get even more money as their students tend to borrow more. Needless to say parents still pay if even the student does not borrow. In other words, Colleges and Universities—-Democrat party monopolists—-always get their money.
There is a useful idiot aspect to this Biden give away. If one owes 50 grand, they will now owe 40. But they still have to pay—-and each year rates have been rising. But their universities, like Paulie in Goodfellas, always gets paid. Schools pay no taxes—-which creates more admin jobs that are useless.
Still, students not hate their schools? They get fed politically correct nonsense on the one hand, which they feel good about—vote democrat, and favor more socialist type government. The universities are Lenin (analogy) and the students are useful idiots.
vince
Aug 25 2022 at 11:10am
“Today, I feel like a sucker. If only I’d encouraged her to borrow $10,000 for college. ”
And what about those for whom college was too expensive? That $10,000 might have made the difference between going and not going. On average, now they are destined to make $1.2 million less over a lifetime.
Jose Pablo
Aug 25 2022 at 11:49am
“On average, now they are destined to make $1.2 million less over a lifetime.”
If college students are “destined” to make $1.2 million MORE over a lifetime, why is Mr. Biden saying that they are “saddled with unsustainable debt.”?
“Unsustainable” should mean that the debt cannot be repaid with the additional $1.2 million they will make, right?
To me it can only mean 3 things:
a) the average student debt is more than $1.2 million
b) the $1.2 million figure is false or, at least, the average of a distribution distorted by a few ultra-high earners with a very much lower median of students making less extra money than the value of their actual debt
c) President Biden is using a populistic hyperbole destined to mobilize voters and retain control of Congress next November.
I tend to believe hypothesis c) is the right one …
vince
Aug 25 2022 at 12:08pm
According to the official Fact Sheet, the typical undergraduate WITH LOANS graduates with NEARLY ….. 25,000 in debt. The Fact Sheet is amazing.
Jose Pablo
Aug 25 2022 at 12:43pm
So, if a college student is “saddled with an unsustainable debt” of $25,000, what is the sustainable level of debt a plumber can take to buy the tools required by his/her trade?
And an independent truck driver owning his/her own truck?
Is there any Federal debt program out there to help this people out?
vince
Aug 25 2022 at 11:12am
“But there are also many hidden taxes on thrift”
And one if inflation, including inflation targeting.
Jose Pablo
Aug 25 2022 at 11:37am
“And one if inflation, including inflation targeting.”
Yes!!!
Jose Pablo
Aug 25 2022 at 12:07pm
But you know Vince, transforming “savers” into “suckers” at, if lucky, a 2% compounding annual rate is required, or so the experts say, to have room to “save” the economy reducing interest rates in a downturn.
Which basically means that “savers” get screwed twice: in good times they lost 2% of the value of their savings every year (compounded) with the main objective that when the mythical rainy day finally arrives the “price”(interest rate) of their very valuable savings can be reduced to zero (or negative).
But this is all technically required, you know, to leave room in a downturn for the monetary authorities to bail out people with very poor investing judgement.
vince
Aug 25 2022 at 12:12pm
Yes, if we have a downturn, it must be due to interest rates. What else could it possibly be? Those darned interest rates. 😉
Jose Pablo
Aug 25 2022 at 12:54pm
“As for efficiency, this policy not only reduces the incentive to save, it encourages colleges to be less careful about holding down costs.”
Even worse, it increases the future marginal tax rate for college students. Working hard to increase their salaries would mean paying back 5% of these increases as debt repayments. This should make college students less productive.
And this bad incentive could have been easily avoided (in fact reversed) by introducing a tax credit scheme allowing college students to reduce from their future tax liabilities the amount of debt repaid during the year with a maximum of 5% of their income.
I guess the tax credit scheme electoral effect was not deemed strong enough by the President’s advisors.
vince
Aug 25 2022 at 1:06pm
Rubbing salt into the wound: The 5 percent is on discretionary income, not gross income.
Jose Pablo
Aug 25 2022 at 1:30pm
“I guess public choice theory is not my forte”
That is probably the right framing to discuss this measure.
Obviously, the main reason behind this initiative is to help the Democrats to keep control of Congress in November. But even with this objective in mind the measure is far from the best one available and reflects, I think, poor political judgement.
There are two main constituencies this measure tries to influence:
a) Diehard democrat voters with the objective of “mobilizing” those among them tempted not to vote in November.
With this idea in mind the most effective path would have been a plan among similar lines but saying that the President strongly believes he should not relay in his executive authority and that the measure, with the President full support, should be approved by Congress too … so, “vote in November for us if you believe if you want to save students saddle with unsustainable debt!“.
In any case 60% of Democratic voters do not have a college degree (but they will pay for this debt relief). Not that sure on the net effect on this constituency
b) Swing voters are younger and more educated, so maybe the measure works with them. But reportedly, the main issues that swing voters care about are climate change, health care and immigration. That was back in 2020, nowadays sure abortion is high in this list too.
Putting the spotlight on the student debt forgiveness take the attention out of these themes where the democratic party is stronger and redirect the debate to an issue in which they hold a weaker stance.
I don’t know. The measure does not look particularly smart to me when judged by their probabilities of getting the political consequences it is looking for.
Jose Pablo
Aug 26 2022 at 9:22pm
Some Democratic candidates seems to agree …
https://www.wsj.com/articles/some-vulnerable-democrats-cool-to-bidens-student-loan-relief-plan-11661506201?mod=hp_lead_pos6
Philo
Aug 25 2022 at 6:28pm
Explicit taxes are usually on activities that we don’t really want to discourage, so they look bad. From a politician’s point of view, a hidden tax is best. There are many similar examples from the art of politics. For example, a legal restraint on the activities of private individuals can be messy, since it may have to be backed up with coercive force applied to some of those individuals. A legal restraint on the activities of businesses is much more attractive, politically: the interface with the public is much neater, almost unnoticed by most people.
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