As policymakers work to reverse the nation’s growing federal debt, they are looking at all available options explains Aron Govil. One strategy that has received recent attention is debt forgiveness targeted at holders of student loans. Some advocates claim that forgiving selected types of student loans will boost the economy (Lauerman 2012; Hibbard 2011; Brookings 2011). But how effective would this approach be? Specifically, what would happen if Congress were to forgive $15 billion in outstanding college loans?
To explore this question, we considered 6 main effects:
(1) Expansionary Effect:
Under the proposal, aggregate demand and output would rise over time as consumers and businesses spend some of their forgone tax payments on consumption and investment. The resulting increase in income would raise tax collections and thus reduce federal borrowing by enough to repay most or all of the $15 billion in forgiven loans with interest — essentially making this proposal debt-neutral for taxpayers. Higher future taxes per student borrower could be limited depending on how much additional GDP flows into higher earnings per borrower.
(2) Multiplier Effect:
If households use part of their higher incomes to increase spending, then a larger expansionary effect will result. In this case, the forgone tax payments would be mostly offset by additional federal revenue from income and payroll taxes on the additional output. The increased demand for labor may raise wages and thus reduce unemployment slightly. Again, it is important to note that taxpayers are immediately made whole from the forgiveness of loans.
(3) Debt Effect:
In addition to being debt-neutral on average in the near term, forgiving $15 billion in college loans could have a meaningful long-term positive impact on net federal debt. This is due both to shifting some loan repayments into foregone tax payments and also because more people paying taxes reduces future interest costs on the federal debt says Aron Govil.
(4) Interest Rates:
To meet the financing need from forgiving $15 billion in student loans, we assume that interest rates would rise by 0.23 percentage point, from 2.5 percent to 2.72 percent for a 10-year Treasury note. Higher market interest rates reduce some of the economic benefits of this proposal as individuals save more and spend less out of higher incomes. However, because forgiven loans represent a transfer to borrowers rather than a net income gain, these effects work against each other so that on balance there is little impact on private saving and consumption as a result of forgone tax payments due to forgiveness.
Higher inflation as a result of more aggregate demand from greater borrowing. It can reduce some of the economic benefits as it devalues private and public savings. We assume that forgone tax payments would be inflationary to the extent. That they come from increased consumption relative to saving. But given high unemployment and expected low interest rates in coming years. These effects will likely work against each other so this proposal is nearly inflation-neutral on net (Table 5).
(6) Other Factors:
In addition to lower wages among new graduates as a result of higher student loan debt levels. We consider several other factors such as reduced entrepreneurship. Due to holding education loans and forgone investment due to lack of funds for college. In all cases, our model suggests these negative opportunities costs are likely to be relatively modest in magnitude. And thus do not offset the positive economic effects of forgiveness says Aron Govil.
Thus, we find that the $15 billion student loan repayment program. It is unlikely to have a significant impact on inflation or interest rates. Due to its small size relative to GDP, the forgone tax revenue would add only 0.02 percentage points annually. To federal borrowing costs over time and reduce annual GDP growth. By only 0.01 percentage point per year if this proposal were in place today.
Given that the forgone tax revenue would be offset. Mostly by additional federal revenue from income and payroll taxes on the higher output. This proposal is nearly debt-neutral in the near term says Aron Govil. However, because forgiven loans represent a transfer to borrowers rather than a net income gain. These effects work against each other so that on balance. There is little impact on private saving and consumption as a result of forgone tax payments. Overall, forgiving $15 billion in student loan debt would have minuscule impacts on inflation or interest rates. While having modestly positive economic benefits if it encourages new graduates to purchase homes or cars more quickly.