Graduates STOCK

Editor’s Note: This story, which was originally published on May 26, has been updated.

Washington CNN  — 

President Joe Biden is canceling some federal student loan debt, making a once pie-in-the-sky idea a reality.

The application officially opened Monday, allowing low- and middle-class federal student loan borrowers to apply for up to $20,000 in debt relief.

But while some Democrats have urged the President to erase large amounts of student loan debt for 43 million Americans with the stroke of his pen, the implications of such a significant policy move are complicated.

There are upsides and downsides.

On the one hand, student debt cancellation will deliver financial relief to millions of Americans, potentially helping them buy their first homes, start businesses or save for retirement – all investments that may take a back seat to pay off student debt. Loan forgiveness could also help narrow the racial wealth gap, some experts say.

But broad student loan forgiveness also shifts the cost – likely hundreds of billions of dollars – to taxpayers, including those who chose not to go to college or already paid for their education. Loan cancellation could also add to inflation while doing nothing to address the root of the problem: college affordability.

“This is a pretty complex issue,” Education Secretary Miguel Cardona told MSNBC’s Symone Sanders earlier this year when she pressed him on why broad student debt cancellation hasn’t happened yet.

Borrowers currently hold $1.6 trillion in outstanding federal student loan debt, more than Americans owe in either credit card or auto loan debt. About 54% of borrowers with outstanding student loan debt owed less than $20,000 as of March 2021, according to the College Board. About 45% of the outstanding debt was held by the 10% of borrowers owing $80,000 or more.

Compared with other kinds of debt, it’s extremely difficult to discharge student loans in bankruptcy. Prior to the pandemic, thousands of borrowers had their Social Security checks garnished because their student loans were in default.

Federal student loan payments and interest accrual have been frozen since March 2020 due to a pandemic-related pause that Biden has extended several times. Payments are set to resume after December 31.

Student loan debt cancellation won’t lower the cost of college

A one-time cancellation of federal student loan debt does nothing to bring down the cost of college for future borrowers or those who already paid for their degrees.

“Forgiving debt does not affect college affordability at all,” said Douglas Holtz-Eakin, president of the American Action Forum, a conservative think tank, and former director of the nonpartisan Congressional Budget Office.

In fact, it might even drive up the cost of college, he said. If prospective students have reason to believe that a future president may cancel their debt, they may be more willing to borrow more money – and colleges, in turn, may decide to charge more for tuition and fees.

“It creates this moral hazard and sets up an expectation that debt may be forgiven in the future,” Holtz-Eakin said.

Biden has acknowledged that college affordability is a problem and called for making community college free – but that move would require an act of Congress. The proposal was cut from the Biden-supported Build Back Better bill, which passed the House but stalled in the Senate.

Along with Biden’s August announcement about canceling up to $20,000 in federal student loan debt, he also said he would create a new plan that would make repayment more manageable for future borrowers.

The new income-driven repayment plan is expected to cap payments at 5% of a borrower’s discretionary income, down from 10% that is offered in most current plans, as well as reduce the amount of income that is considered discretionary. It would also forgive remaining balances after 10 years of repayment, instead of 20 years, and cover the borrower’s unpaid monthly interest.

But it remains unclear when these changes will take effect. The Department of Education has not provided any sense of timing, but has said it will propose a new rule to create the repayment plan. The department’s formal rule-making process usually includes soliciting public comments and can take months, if not more than a year.

An economic boost? Or higher costs for all?

A lot of borrowers say that having less student debt hanging over their heads could help ease the pain of rising inflation.

Now that Biden is canceling some student loan debt, it’s true that some borrowers will owe less money on a monthly basis and in turn, have more money in their pockets. But more consumer spending could add fuel to an already overheated economy.

“It’s a situation where what’s good for individuals is not necessarily good for society,” said Beth Akers, a senior fellow at the conservative American Enterprise Institute, where she focuses on the economics of higher education.

“In reality, it probably wouldn’t move the needle drastically in either direction. But the downside for cancellation got a bit worse since we entered this inflationary period,” Akers added.

One reason the economic impact may be modest is because borrowers generally pay back their student loans over time. They wouldn’t receive a lump sum of money if some of their debt is canceled. They would instead be required to pay less money each month toward their student loan payments.

The nonpartisan Committee for a Responsible Federal Budget has estimated that Biden’s student debt policies, including the forgiveness and payment pause extension, will likely boost inflation between a sixth and a quarter point over the next year.

The cost of canceling student loan debt will add to the deficit – transferring the cost from borrowers to all taxpayers.

The Congressional Budget Office has estimated that Biden’s student loan cancellation program could cost $400 billion. Similarly, the White House estimates that the program will cost an average of $30 billion per year over the next decade and $379 billion over the course of the program.

Helping poorer households as well as high-earners

There are certainly many low-income Americans who are struggling to pay off their student loan debt. But it’s not easy to target loan forgiveness to those who need it the most and exclude borrowers with higher salaries.

Many economists argue that canceling student loan debt would disproportionately benefit higher-wealth households, like those of doctors and lawyers, because those borrowers tend to have more student debt after attending graduate school.

Biden established an income threshold that cuts off borrowers who earn more than $125,000 a year, helping to make sure a bigger proportion of the relief goes to low-income borrowers. He also is awarding additional relief to borrowers who received a Pell grant while in college. The grants are generally awarded to the lowest-income families and don’t need to be repaid.

About 75% of the benefit of the loan forgiveness program will go to households making $88,000 or less per year, according to the Penn Wharton Budget Model, an independent research group.

The White House argues that an even bigger share of the relief dollars, nearly 90%, will go to those earning less than $75,000 a year.

But those Americans who did not go to college or already paid off their student loans won’t see a direct benefit from Biden’s program.

About 81% of households who earn less than $125,000 a year don’t have student loan debt, according to an analysis done earlier this year by Matthew Chingos, vice president of education data and policy at the Urban Institute. He based the estimation on the 2019 Survey of Consumer Finances conducted by the Federal Reserve.

Some loan forgiveness programs already exist, but they don’t always work

There are already federal student loan repayment programs that exist to help borrowers who are struggling to make their payments or were victims of for-profit college fraud.

Most federal student loan borrowers are eligible for loan repayment plans that tie their monthly payment amount to their income and family size, known as income-driven repayment plans. There are a variety of plans, but generally they cap payments at 10% of a borrower’s discretionary income. After 20 or 25 years of payment, depending on the specific plan, the remaining student loan debt is forgiven.

But the programs are messy and don’t always work the way they should. A March Government Accountability report found that few people have qualified for forgiveness under an income-driven repayment plan. The Department of Education had approved forgiveness for a total of 157 loans as of June 1, 2021. Meanwhile about 7,700 loans in repayment may have already been eligible for forgiveness.

The federal government also offers a student loan forgiveness plan for public sector workers who make 10 years of qualifying monthly payments. But the program, known as Public Service Loan Forgiveness, has also had problems that prevented people from qualifying.

The Biden administration has made changes to both the income-driven repayment program and the Public Service Loan Forgiveness program that are bringing millions of borrowers closer to debt forgiveness.

There is also a government forgiveness program for borrowers who enrolled at schools that shut down while they were enrolled or fell short of delivering the education the institutions promised. The Biden administration has been chipping away at a backlog of forgiveness claims filed under this program, known as borrower defense to repayment.

Altogether, as of August, the Department of Education has approved $32 billion in student loan debt forgiveness under Biden.