How Will Student Loan Forgiveness Impact the Economy & What Should Borrowers Do?

By Brian Seay, CFA

Founding Partner, Capital Stewards

Q4 2022 UPDATE: STUDENT LOAN FORGIVENESS IS TIED UP IN COURT, WE WILL PROVIDE AN UPDATE IF THE PROGRAM MOVES FORWARD.

On August 24th, President Biden announced a plan to forgive $10,000 in student loan debt for most borrowers. That number rises to $20,000 for a smaller number of Pell Grant recipients, a program designed to support low-income college students. It’s also notable that Parent PLUS loans will be included in the program. The White House is limiting the program to borrowers (and parents) with adjusted gross incomes of less than $125,000 for single adults and $250,000 for married couples.

There are two important considerations for our readers to consider. First, how does this impact the economy and college spending long-term? Second, for borrowers, what actions should they take based on the announcement?

What does this mean for those saving for college long-term?

Forgiving student loan balances creates a significant perverse incentive for colleges and universities. The goal of government should be to create an environment where individuals can acquire education at a price that is rational. Reasonably priced education supports long-term economic growth. Forgiving student loan debt does the opposite by encouraging colleges to charge more than free markets support for education because students can borrow more, hoping that the debt will be forgiven down the road. Ultimately this will result in marginally higher taxes as the burden of college is shifted to taxpayers. Long-term, this will make college more expensive, not less. Our view is that, while this policy may feel great near term, it will make college more expensive long-term. This will ultimately hurt the very people the administration is attempting to help.

What is the impact on inflation and the economy?

In our view, the impact on inflation and the economy will be minimal. According to the Department of Education, there are 29.3 million student loan borrowers with less than $40,000 in outstanding debt. In our view, this is the population that will see their balances and payments drop by one-third or more. For borrowers with larger balances, their monthly payments will decline by less than one-third and we would expect their spending behavior to be unchanged. Additionally, high-income borrowers are unlikely to change their spending behavior if a relatively small amount of debt is forgiven. After adjusting for these factors, we estimate that 22 million borrowers will have an additional $16.2 billion that could be spent each quarter. Consumer spending in the U.S. totals around $17 trillion each quarter, thus the incremental capital adds approximately 0.09% to consumer spending. Hardly a rounding error when inflation is running north of 7%.

What should I do if I have outstanding student loans?

The full text of the law has not been released, so its important to keep in mind that things could change. Additionally, while unlikely, it is possible that a legal challenge will delay or upend the executive action. Regardless of the future, here are the steps we think you should consider immediately:

1)     Consider your current taxable income and manage your remaining 2022 income where possible to be below the threshold.

2)     Sign-up for official updates from the Department of Education for Student Loan Borrowers (https://www.ed.gov/subscriptions). The forgiveness application will be sent to this distribution list when it becomes public.