Student Loan Forgiveness and the Economy

Student Loan Forgiveness and the Economy

Recently the Biden Administration issued an executive order that canceled as much as $10,000 of student loan debt for individual borrowers. The order also addressed remaining balances on all federal direct loans such as the older Perkins Loans provided by colleges as well as non-direct loans held by the federal government. Approximately 43 million Americans may benefit from the relief of these debt obligations, and for an estimated 15–20 million of them, the executive action would entirely eliminate their loan balances.

It is important to note that these benefits would only extend to those with income under $125,000 for single individuals ($250,000 for married couples). Current students with debt are eligible for relief if the student is claimed as a dependent on the parents’ income tax return; eligibility would be determined by the parents’ income. Further, as much as $20,000 in student debt would be forgiven for Pell Grant recipients (the Pell Grant is a program designed for students “with exceptional financial need”), using the income thresholds shown above. “Parent-Plus” loans, which are federal student loans taken out by parents to help their students, also qualify for relief, subject to the same income requirements. According to the executive order, all federal student loan payments and accrued interest would be delayed once again, through December 31, 2022—likely the final moratorium for payments and interest, which would end the COVID-driven pause in student loan payments that began in 2020.

Most of the time, the IRS treats forgiven loans as taxable income. But in this case, the Biden student loan forgiveness program may prove an exception. The American Rescue Plan Act of 2021 provided that most student debt discharged through 2025 (including the Biden Administration’s current order) would be tax-free at the federal level. It is less certain that those states collecting state income tax would consider the debt cancellation to be taxable income.

Certainly, students, graduates, and their parents who meet the income requirements are happy about having $10–20,000 of debt wiped off the books. But how will this affect the economy? With financial markets exhibiting wide volatility driven by the latest measures of inflation, what happens when the federal government erases some $300 billion in debt—and the related interest—from the balance sheet? According to the Tax Foundation, a Washington, DC–based nonprofit, the president’s order, in decreasing the government’s “accounts receivable” by such a large amount, would be inflationary, largely canceling the benefits of the recently enacted Inflation Reduction Act (IRA) of 2022. Supporters of the measure counter, however, that the practical effect only extends to the payments and interest that would have been collected in a single year, thus distributing the impact of the cancellation over the entire term of the original repayment plan. By this calculation, the effect on inflation would be negligible.

We should also keep in mind that the Department of Education makes some $90 billion in new student loans every year—and no one at present is talking about whether or how any of those loans might, in the future, be forgiven.

At JFS Wealth Advisors, our priority is providing well-informed research and guidance so that our clients can make the right decisions for their financial futures. To learn more, view our recent student loan webinar, “Navigate Your Perfect Plan.”

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