• Tag Archives student loans
  • If Student Loans Might Be Forgiven, Why Not Borrow More?


    It’s one of the rules of electoral success: advocate policies that concentrate the benefits on an easy-to-identify interest group (preferably one that is sympathetic in the public eye) and disperse the costs onto the entire electorate. It’s how we get Coke sweetened with corn syrup rather than actual sugar. It’s also how we get proposals to cancel student loans. As my AIER colleague Will Luther points out, the fact that two of the Democratic frontrunners have made debt cancellation such an important part of their campaigns suggests that the issue is going to be with us for a while.

    But would it be a good idea to cancel student debt? And importantly, how does even the prospect of canceled student debt affect people’s incentives?

    First, let’s consider the quality of the policy. A lot of commentators are pointing out that it’s fundamentally regressive, meaning that we’re basically taxing the poor to pay the rich. As economist Alexander William Salter puts it in the Dallas Morning News, it’s

    a transfer of wealth to those with relatively high levels of expected lifetime income, at the expense of those with relatively lower levels of expected lifetime income.

    The idea might have some merit, but it will make wealth and income inequality worse rather than better.

    Even saying that the idea might have some merit is perhaps too charitable. In 2011, economist Justin Wolfers called it the “Worst. Idea. Ever.” in a Freakonomics post. Why? First, there’s the distributional effect. If we’re going to have policies that transfer wealth from one group to another, it doesn’t make much sense to transfer wealth from taxpayers generally to high-income college graduates. As Will Luther and so many others have pointed out, a college degree brings spectacular financial returns. As a group, college graduates aren’t “needy” by any reasonable definition.

    Second, Wolfers points out that debt cancellation doesn’t make college more affordable because it’s a transfer to people who already went to school and who are already enjoying the returns on their investment. Third, he notes that a successful campaign to cancel student debt will encourage further wasteful lobbying for transfers. The “cancel debt” movement is already part of the fallout from past bailouts, subsidies, and transfers. Capitulating will only encourage more lobbying.

    Hence, I think we would do well to focus on the downstream effect debt cancellation—or even the reasonable prospect thereof–will have on people’s future incentives. Encouraging people to produce and exchange rather than lobby for transfers and special privileges are important parts of the problem of constitutional design that has animated so many scholars, among them Douglass C. North and James M. Buchanan.

    The prospect of being able to enjoy good times now and stick other people with the bill later encourages people to be less-than-completely-responsible right now. My kids are seven, nine, and almost-eleven, and we’re very fortunate in that I work at an institution with an employee tuition benefit (which means, of course, that my salary is lower–so it’s not exactly “free” tuition), but there are a lot of other expenditures that go into college beyond tuition. If student debt cancellation is on the horizon within the next couple of decades, we now have an incentive to change how we plan to finance their college education and what they plan to study.

    There are three important effects here. First, the prospect of student debt cancellation encourages us to finance the entire thing with borrowed money. Why pay now or go to the trouble of trying to earn scholarships if we can borrow on the cheap and have a reasonable expectation that taxpayers will ultimately be left with the bill? Second, why should we be price-sensitive college shoppers, and why should colleges work to contain costs if there’s a good chance it will all be paid for with other people’s money? Third, we have incentives to borrow a lot of money to pursue boutique degrees with limited job prospects if (again) we know that someone else is going to pay the bill.

    As EconTalk host Russell Roberts explained it in the mid-90s, if we go to a restaurant and know that someone else is paying, we have incentives to order the best thing on the menu, drinks, appetizers–the whole lot. If you go to dinner with a few friends, it’s relatively easy for you to monitor one another and check anyone who seeks to take advantage of the situation. It’s a lot harder to do this in larger groups, and as the benefits get more concentrated and the costs get more dispersed over a larger and larger population, people have stronger incentives to take advantage of everyone else. What’s more, given our psychological proclivities and our tendencies to be self-serving, it can be pretty easy to convince ourselves that we’re actually doing everyone a favor by borrowing tons of money to study something that doesn’t translate into employable skills.

    Student debt cancellation is already suspect because it redistributes wealth upward. As we can see, the prospect of debt cancellation changes people’s incentives for the worse. I don’t know if I would call it the worst idea ever, but it’s certainly not a good one.

    This article is republished with permission from Forbes. 

    Art Carden

    Art Carden is an Associate Professor of Economics at Samford University’s Brock School of Business. In addition, he is a Senior Research Fellow with the Institute for Faith, Work, and Economics, a Senior Fellow with the Beacon Center of Tennessee, and a Research Fellow with the Independent Institute.

    This article was originally published on FEE.org. Read the original article.

  • How Government-Guaranteed Student Loans Killed the American Dream for Millions

    In Basic Economics, Thomas Sowell wrote that prices are what tie together the vast network of economic activity among people who are too vastly scattered to know each other. Prices are the regulators of the free market. An object’s value in the free market is not how much it costs to produce, but rather how much a consumer is willing to pay for it.

    Loans are a crucial component of the free market because they allow consumers to borrow large sums of money they normally would not have access to, which are later paid back in installments with interest. If the borrower fails to pay back the loan, the lender can repossess the physical item the loan purchased, such as a house or car.

    Student loans are different. Education is abstract; if they’re not paid back, then there is little recourse for the lender. There is no physical object that can be seized. Student loans did not exist in their present form until the federal government passed the Higher Education Act of 1965, which had taxpayers guaranteeing loans made by private lenders to students. While the program might have had good intentions, it has had unforeseen harmful consequences.

    Millennials are the most educated generation in American history, but many college graduates have tens of thousands of dollars in debt to go along with their degrees. Young Americans had it drilled into their heads during high school (if not earlier) that their best shot—perhaps their only shot—at achieving success in life was to have a college diploma.

    This fueled demand for the higher education business, where existing universities and colleges expanded their academic programs in the arts and humanities to suit students not interested in math and sciences, and it also led to many private universities popping up to meet the demands of students who either could not afford the tuition or could not meet the admission criteria of the existing colleges. In 1980, there were 3,231 higher education institutions in the United States. By 2016, that number increased by more than one-third to 4,360.

    Secured financing of student loans resulted in a surge of students applying for college. This increase in demand was, in turn, met with an increase in price because university administrators would charge more if people were willing to pay it, just as any other business would (though to be fair, student loans do require more administration staff for processing).  According to Forbes, the average price of tuition has increased eight times faster than wages since the 1980s. In 2018, the Federal Reserve estimated that there is currently $1.5 trillion in unpaid student debt. The Institute for College Access and Success estimates that in 2017, 65 percent of recent bachelor’s degree graduates have student loans, and the average is $28,650 per borrower.

    The government’s backing of student loans has caused the price of higher education to artificially rise; the demand would not be so high if college were not a financially viable option for some. Young people have been led to believe that a diploma is the ticket to the American dream, but that’s not the case for many Americans.

    Financially, it makes no sense to take out a $165,000 loan for a master’s degree that leads to a job where the average annual salary is $38,000—yet thousands of young people are making this choice. Only when they graduate do they understand the reality of their situation as they live paycheck-to-paycheck and find it next-to-impossible to save for a home, retirement, or even a rainy-day fund.

    Nor can student loans be discharged by filing for bankruptcy. Prior to 1976, student loans were treated like any other kind of debt with regard to bankruptcy laws, but as defaults increased, the federal government changed the laws.  So student debt will hang above the borrower’s head until the debt is repaid.

    There are two key steps to addressing the student loan crisis. First, there needs to be a major cultural shift away from the belief that college is a one-size-fits-all requirement for success. We are beginning to see this as many young Americans start to realize they can attend a trade school for a fraction of what it would cost for a four-year college and that they can get in-demand jobs with high salaries.

    Second, parents and school systems should stress economic literacy so that young people better understand the concepts of resources, scarcity, and prices. We also need to teach our youth about personal finances, interest, and budgeting so they understand that borrowing a large amount of money that only generates a small level of income is not a sound investment.

    Finally, the current system of student loan financing needs to be reformed. Schools should not be given a blank check, and the government-guaranteed loans should only cover a partial amount of tuition. Schools should also be responsible for directly lending a portion of student loans so that it’s in their financial interest to make sure graduates enter the job market with the skills and requirements needed to get a well-paying job. If a student fails to pay back their loan, then the college or university should also share in the taxpayer’s loss. Only when the demand for higher education decreases will we witness a decrease in its cost.

    Daniel Kowalski

    Daniel Kowalski is an American businessman with interests in the USA and developing markets of Africa.

    This article was originally published on FEE.org. Read the original article.